Service contracts for IT: what are the options?

Effectively contract IT services

Time and Materials or Fixed Price when agreeing IT service contracts….. which is best?IT Contract Image

In this age of ITaaS utilisation IT managers are often asked to become involved in the creation of IT contract service agreements. The following article provides an overview for IT managers of the differences, the merits complexities, and potential commercial impact of two very different options.

Time and Materials v Deliverables

Which direction should you take when constructing the payment terms within an IT project, solution development or IT service contract? Whilst there are many potential permutations the two most common types within the IT sector are: Time and Materials and Fixed Price.

Time and Materials based IT service contracts

Time and materials agreements based on a payment for time expended, plus the addition of any materials costs. Materials unless specifically described as such are not deliverables.

In these contracts the time element is broken down into a unit to which a fixed price is allocated for the duration of the agreement. The units then potentially aggregated into an estimated duration for the provision of the service and hence total cost for budgeting purposes.

The actual total payment for a time and materials contract (or amount of time to be expended) can also be agreed at the outset which would give a cost ‘ceiling’.

It is important to note that no expectation by the purchaser should be placed on the provision any ‘deliverables’ by the service provider accept for the use of any ‘materials’ to be used.

When to never use time and materials contracts

Time and Materials contracts should never be utilised in an attempt to specify the actual work to be completed, but only an amount of time for the provision of a required level of service or expertise.

The reason for this stipulation is that expectation by either party over the amount of time needed to deliver a specific outcome, invariably varies and disagreement and disappointment always follows.

Are time and materials contracts the solution?

By their very nature, time and materials contracts are very easy to understand. The price for each time unit can easily be compared to the price for comparable services which will provide a comparative measure that the price is reasonable or within expected limits. These types of agreements are a very useful contracting tool where the actual deliverables are unknown or difficult to quantify at the outset.

Of course there can be a down side for the purchaser that a lack of knowledge of the service to be provided brings difficulty at the price comparison stage. This lack of knowledge will inevitability lead to the purchase of an inappropriate service usually resulting in an eventual price increase, or a reduction in quality.

Another difficulty with T&M arises in that the output of actual effort expended is very difficult to measure and can lead to subsequent concerns over deliberate delay or lack of effort on the part of the service provider. If the situation is allowed to continue it leads to mistrust and possibly need for constant supervision increasing any previously un-estimated costs.

Real life experience of Time and Materials contracts for IT services

It is my experience that Time and Materials contracts for the supply of IT services are often miss-used and miss-understood. Time and Materials agreements should always assess quality ‘up front’ which must be assessed utilising a given price and experience.

Difficulty arises if the purchaser;

  1. has not understood the pricing points for service quality,

and

  1. has taken a purely price based purchasing decision.

Taking this approach also completely over-looks the fact that ‘risk elements’ have been transferred from the provider to the purchaser. Which is acceptable if risk transfer allows a lower price to be quoted in the first instance.

Personally, I would only recommend a T&M IT service agreement where tangible deliverables can-not be ascertained initially, and only used for very short time periods.

Fixed price IT service contracts

Fixed Price contracts are based on the principle of an agreed fixed price for a tangible deliverable output or outcome (referred to here as ‘deliverables’). The construction of a fixed price contract requires clear terms or detailed discussion between the parties to ensure clarity over the actual ‘deliverables’ being discussed and the various potential approaches to payment. To reduce the possibility of future disputes these ‘deliverables’ and the payment approach should be documented and formally agreed within the terms of the contract.

It is the nature of the complexity of IT deliverables that over time things may and will change and the original expectation or needs also change. Good fixed price contract agreements are written with this in mind and are able to ‘flex’ with any change to ensure neither party is in at a disadvantage resulting in a dispute or eventual dissolution.

Critique of Fixed Price IT service contracts

Fixed price contracts require more time to construct and agree but the purchaser and provider will have assurance that the expected ‘deliverables’ are understood by all.

The price to ‘acquire’ the deliverables and how they are paid for is also clear, potential changes also have an element of control, and any risk is reduced in relation to non-delivery.

Fixed Priced Contracts are commercially complex

As an example; if the transfer of risk for non-delivery or performance is placed in the hands of the purchaser, a premium will have been paid for the fixed price but to no advantage over what could have been a lower priced time and materials contract.

The supplier should be ultimately responsible for providing the appropriate resource, capability and capacity to achieve the deliverable. In this instance the risk is owned (or ‘insured’) by the supplier, but if a joint effort is required, then negotiated stipulations will need to be placed on the purchaser to ensure that the supplier is not prevented from achieving deliverables.

The added value to the purchaser of a fixed price IT contract

The added value to the purchaser of a fixed price contract lies in the certainty in price for what is being procured, and knowing where the risk for non-delivery lies.

But to ensure that this ‘value’ is obtained it is essential to be able to weigh and understand the value of the ‘risk price transfer’ during contract agreement and construction.

 

About David Cox Consulting: With many years of experience negotiating and supporting clients to get the best from IT contracts contact me if you are looking for commercial support when procuring IT goods and services.

 

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