How to navigate the changing trends in contract negotiations

Success for consulting firms and consultants depends on negotiating a good contract. Today that means understanding the new and increasing concessions that clients are demanding. Learn where it's happening and how to protect your business.

A recent survey by Merrill Lynch found that spending on IT consulting contracts will drop by almost 5 percent this year. The biggest reason is a lack of discretionary funds to pay for consultant-heavy projects. Because of tighter IT budgets, companies using consultants are demanding more price or service concessions during contract negotiations.

To protect your interests during contract negotiations, you must know what concessions clients may expect in various contracting situations. Knowing what type of contract suits your firm best is also vital to making good business decisions.

Where big concessions are being made
Many contract types exist in the consulting market, especially in the public (government) sector. The statement of work (SOW) is the predominant contract under more scrutiny regarding client demands for consultant concessions.

The concessions being requested vary depending on whether the consulting firm is working in the public or private sector, and whether the contract is being written on a fixed-cost vs. a T&M (time and materials) basis. These are the two main contracts for which clients are requesting concessions.

Why fixed cost is popular in public sector
Most public sector consulting firms are predominantly writing SOWs on a fixed-cost basis. Many of the projects are for the development of “known” technologies vs. those that require the development of more “beta”-type endeavors.

“Known” or proven technology efforts represent much less risk to the client. They also are less risky for the consultant in successfully delivering the final product. With tighter budgets, few public clients have the green light to take on the more risky “unknown” development efforts.

Public clients want fixed-cost contracts to ensure that budgets are not exceeded. Consulting firms are staffed with experts who have proven track records specific to the project's needs. Consequently, estimates are easier to create—the consultants basically provide iterative development efforts and know what to expect and estimate.

Client-requested price concessions in the public fixed-cost arena aren't that prevalent. What is becoming more typical is the need for the consulting firms to provide more services. Financial models such as NPV cost-benefit analyses, ROI analyses, decision trees, pair-wise comparisons, and the analytic hierarchy process are being performed more often.

Project planning requests often involve centralized project functionality and resource pooling with viable estimating techniques (such as function points). All of these services are being sought as concessions from consulting firms if they want to gain contract approvals.

These services are requested to ensure that estimated costs better match actual performance so that budgets are not compromised. With budgets tight on both sides, this optimizes success for both parties. It's the predominant area of change in the fixed-price public contracting process for consultants. Price concessions are also being performed to some degree, but they're not a result of client requests as much as a result of the typical competition for gaining contracts.

Concessions in public sector
As I mentioned earlier, unknown technology or beta projects aren't popular right now. Nevertheless, they're still being performed. The prime driver of concessions in these SOWs is the desire to fully drive out requirements. Concessions written into these SOWs demand even more thorough financial models, system models, prototypes, and project plans. This is done to better ensure that results will meet expectations and consequently achieve success.

These SOWs are usually written on a T&M basis. Public sector players want to be sure requirements are carefully and thoroughly captured in this “discovery” mode project type. They need the effort to fully deliver results and cannot compromise scope or quality.

Fixed-cost pricing adds too much risk to the project, and public sector players prefer T&M SOWs. Consultants also believe that these projects have a great deal of associated risk and will not generally lock themselves into fixed-cost prices. The need for effective end results typically requires the T&M SOW contract. Contract concessions involve an elevated level of consultant analyses, models, and plans. Price concessions, such as reduced labor rates, are not that typical either.

Private sector concessions
Contract concessions in the fixed-price private (commercial) sector vary when compared to the government contracts sector. It's similar in that contract concessions are being requested and made for enhanced modeling, prototyping, and planning services. What is different is that there is a definite demand for reduced pricing while fully delivering results.

SOW contracts that offer awards or bonuses (cost plus fixed fee, cost plus incentive fee, or cost plus percentage of costs) are becoming rare. Fixed-price contracts in the commercial sector are quickly becoming strictly “firm-fixed cost” SOWs. When time to market is an extremely important concern to the private enterprise, only then are bonuses and/or awards considered, and even then, the amounts are being reduced.

Price concessions also involve reductions in the percentage amounts paid in advance for fixed-price contracts. If a consultant typically charges a 50 percent up-front fee for a fixed-price SOW, client requests are being made to reduce this amount. The reduction amounts vary, but the common thread is that private companies want to pay less in advance. They want to use future payments as an incentive for the consultant to deliver results. They also want to delay payments to maximize bottom-line performance with more extended investment periods.

Another price concession involves the cost of intellectual property rights and access to source code and documentation. Private enterprises are often requesting, if not expecting, full access to developed source code and documentation as an embedded cost of the project. This often can become a very difficult area to overcome in contract negotiations.

Just as with the public sector, private sector T&M contracts are becoming a little rarer. Typically, they too involve discovery or beta-type development efforts of new and emerging technologies. Many of the clients and consultants surveyed by Merrill Lynch indicated that .NET 1.0 and converged voice and data network solutions were some of the typical projects involving discovery T&M SOW contracts today.

Client price concessions are being requested, and made, to reduce consultant hourly rates in these T&M projects. Also, the consultants are being pressured to offer discovery SOW contracts on a firm, fixed-cost basis. This can be disastrous for the consulting firm.

I recall a project I was involved in about three years ago as the manager of an IVR/CTI functional team in a call center environment. A very reputable consultant had been hired nine months earlier to deliver Web/e-mail/chat functionality. It was a new technology at that point and fully in the discovery mode. The consultant was hired because his firm was the only one that would agree to a firm fixed-price contract.

The project was already three months overdue when I started, and it was completed eight months later—11 months overdue. The consultant provided a project manager and two senior developers along with a few other resources. The project manager’s typical T&M rate was $125/hour, and the developers were typically charged out at $175/hour. Given the 50-hour workweek, the firm’s lost fees for the three staffers amounted to approximately $1,132,000.

Obviously, the firm’s business suffered greatly. By accepting a discovery project on a firm fixed-cost basis vs. what should have been a T&M contract—in addition to not employing viable estimating, modeling, and planning procedures— the firm greatly compromised bottom-line performance and reputation. This is a good example of what not to do in protecting oneself in contract negotiations.

Protection to take
There are many ways to protect your consulting firm in contract negotiations:

Know your client and the project
If you need more information about the client and the project, the first step is to research—check out business partners and vendors; they can all help beyond discussions with the organization. Try to learn from past consultants and vendors what kinds of concession the company has asked for in previous projects. Benchmarking competitors can also be quite beneficial. Knowing the concessions a client typically expects when negotiating fixed or T&M contracts can help immensely in decision making when tailoring a contract proposal.

Get skills up to par
Understanding your firm’s technological staff expertise is paramount, and just as important is knowing that you have best practices and expertise in financial and system modeling, prototyping, and project planning in making concession agreements.

Know what you can accept
Dealing with client price concessions in the commercial arena often involves reduced contract revenues and the need to consider reducing internal labor rates, organizational costs, or earnings expectations. This can be a tough area to deal with and must be addressed if clients are beginning to demand these concessions. Basically, you need to know if your bottom line can survive any concession.

Eliminate surprises
The key to knowing when or if to agree to a fixed-price or T&M SOW contract is knowing your staff, its expertise, and how each contract scenario would work for you before signing the contract.

If a client's demands for concessions exceed your firm’s best interests, you have to be ready to pull the plug on the negotiations or stand your ground and hope the client concedes to your logical and rational expectations.

Employing these techniques will better position your firm in making sound decisions when dealing with client concessions in the public and private sectors. By doing so, you’ll be able to protect your firm well when negotiating your consulting contracts.

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