Agile business requires agile contract management. And agile contract management requires agile types of contracts.
But why would you want to “go agile”. The agile methodology seems really the domain of IT and software development but how does that work for contracts in the aerospace, defense, and high-tech equipment industry?
And how do you know which type of ‘agile’ contract to use? And what is different in managing an agile contract compared to a standard contract?
Do you need to change your organization, introduce agile processes and train your people in agile ways of working?
In this post, I will further explore what agile contract management is and which types of contracts you can use in agile. I will end with some words on the impact of agile contract management on your people and organization.
I will show that agile contracts can really help you add value to your customer and your won company. And also that agile contract management is a mindset that may not always be easily adapted by management, lawyers, contract managers, and other contract specialists who have been educated to work in more traditional ways for hundreds of years and resist change.
Where does Agile Management Come From?
Today you have to deal with continuous change, volatility, uncertainty, complexity, and ambiguity, and a customer-driven marketplace. Agile management is a way to cope with this.
Agile started as a set of mainly agile project management practices relevant to software development. However, the most valuable ideas came from outside the agile software development industry in the first place as adaptations of approaches in managing product development, or production lines (like Kanban).
You can read more about the history of agile in another post I wrote on agile contracting.
Following the appearance of the Agile Manifesto for software development in 2001, agile ways of working started to spread into other areas of activity.
Agile has now spread rapidly to other types of organizations. This includes manufacturing, aerospace, and other high-tech industries.
Also, other processes in organizations are also becoming agile. Agile contract management is a good example of this.
What is Agile Contract Management?
Agile contract management is an approach that uses the agile methodology, that focuses on being flexible, fostering collaboration, and decomposing projects into smaller and easier tasks.
The questions you need to answer yourself when you are looking at a new project are when do you need agile contracts and what type of contract you should use for an agile project?
Contracts have long been considered fixed instruments that needed clear mandates. Failure to comply leads to harsh consequences, like penalties or termination of the contract.
For years, there has been an unfaltering inflexibility in the way that contracts are negotiated, drafted, and managed.
The idea for parties is to recognize the contractually written obligations as fixed, with the rules for performance clearly stated and demanding near-perfect obedience.
In general, the price, scope, and duration of the contract are clearly defined, and there is little room, if any, for deviations.
This traditional contracting approach still exists, however, there is an increasing movement away from such stringency, as adherence to these rigorous principles has led to costly and time-consuming contract disputes.
Rather than spend enormous amounts of time on negotiations and dispute resolution, there is the recognition that the parties should focus on collaboration and results-oriented action.
It is radically from the traditional way of working with fixed timelines and concrete requirements that need to be agreed upon long before the actual product is delivered and that doesn’t allow change.
This is generally known as agile contracting, and it is changing the way in which contracts are negotiated, drafted, and most importantly, managed.
This article discusses the benefits of creating an agile contract management process, information on different types of agile processes, and four steps to get you started.
Three agile contract types
There are three main types used in agile contracting.
1. Time and Materials Contract
Perhaps the simplest type of agile contract is the well-known ‘time and materials contract’. The other party pays you for both the time you and your people spend on designing, and producing products or rendering services as well as for the materials you use in production and delivery.
In general, even if the risk is low when you spend more time or materials, you will use your time and materials as efficiently as possible to keep the overall costs of the contract for your customer as low as possible in order to maintain a good customer relationship and get more follow-on business.
Your customers, however, have no protection, since they have to pay all additional costs to you if you run over time or need more materials.
So, in some cases, your customer can ask to ‘cap’ the total costs with a so-called ‘ceiling price’.
The idea is that this will give you a further incentive to work efficiently. It protects your customer from potential cost overruns, in which case you’ll be out in the cold since you will not get compensated for extra time and materials you put into the product or project. So from your point of view a capped time & materials contract is less flexible.
However, there is an upper limit to how much customers will have to pay. In this way, suppliers benefit with early time-frame changes while customers only have to pay up until the capped cost limit is reached.
Capped T&M contracts, on the other hand, are designed to put an upper limit on any additional amount a customer might have to pay.
It surely is easier and often more profitable to work with Time & Material contracts. However, it is more difficult to reward people who are working more efficiently and take less time to create features. Also, there is no real incentive to focus on improving people’s skills so that they become more efficient. The hourly or daily rate system prevents this.
2. The Target Cost Contract
A fixed-price contract is out of the question in agile, since you will not commit to fixed prices for variable scopes.
However, you can agree to a “target cost” contract, in which the parties agree on a cost goal for the delivery of a product or service.
In target cost contracts, you agree on a final target cost during negotiation. Parties will save costs if such contracts go below the target cost. However, they also allow parties to share additional costs if the contracts run above such agreed target cost.
This is known as the ‘pain or gain’ mechanism.
This price has to be realistic and takes into consideration your costs to produce the good or service, includes fees that are based on general overhead, and should account for the risk you take upon you in delivering the goods or services.
The underlying idea is that you’ll have an incentive to fulfill the contract at a lower cost than the target cost.
In the event that the supplier is able to spend less than the targeted cost, both parties to the agreement will share in the savings.
However, in the event that the supplier exceeds the targeted cost, both parties will share the financial burden.
The mutual savings in the below target cost scenario, or the shared contributions in the above target cost scenario, are aimed at keeping the overall cost of the contract down.
If you had to assume all of the risk, you would have had to put the projected target cost much higher.
However, in this case, since both parties are penalized for any cost above the target, you can settle the price at a lower target point.
In addition, you have a financial incentive to work more efficiently and find cost savings.
Agile contracting tries to have parties really collaborate toward a common goal instead of penalizing each other or parties ending up in contentious situations. Working with a target cost, there is much more flexibility and a common goal beneficial for all parties involved.
3. Incremental Delivery Contract
The second type is the ‘incremental delivery’ contract. This type of contract allows you to break up a long project into smaller and distinct sub-projects.
In an incremental delivery contract, you agree with the other party (or parties) in the contract that there will be predefined review points during the implementation of the project or service.
At each review point, you and the other party then evaluate performance up to the review point for the relevant sub-project. And then the parties decide whether they wish to change the project, continue as originally foreseen, or terminate the sub-project or the whole project.
Then, all subsequent steps work the same: you incrementally add other features and tools, and the further you get the more the overall value of the particular product increases. It can be seen as a continuous improvement of a product.
The idea is that in each step there are deliverables or components of the system that the other party can immediately use and benefit from.
This method works especially well if you are designing and developing a customized product and you want to allow for building the product incrementally. That’s how agile started since the development of software and other technological tools really require such an incremental approach.
In a traditional contract, you will have to deliver and the other party will have to accept exactly what was agreed in the contract. Even if along the road things changed. Agile methodologies focus on managing work-in-progress and delivering value in each effort/iteration.
In an agile incremental delivery contract, your customer can decide to discontinue further building of the product. This happens when the customer thinks that they have achieved sufficiently of the expected value. Or when the customer realizes the jointly developed product may not give the benefits originally envisaged and it is better to stop development (in which case it will be ‘sunk costs’).
The contract model described above proposed by Jeff Sutherland, named after Dire Straits’ song Money for Nothing and Changes for Free is based on encouraging your productivity.
Conditions Required for Using Agile Contracts
On the 20th anniversary of the ‘Agile Manifesto’ quite a body of knowledge has been created around agile contracting. So what has been the experience until now?
The ‘target cost type of contract is a framework most suitable for technology projects, where scope, delivery roadmap, and costs are complex and that are long so hard to define in advance.
‘However, there are some pre-conditions. To be successful in agile contracting, you and the other party should be willing and able to work together closely throughout the entire life cycle of the project.
This above all requires mutual trust for agreeing on the cost/price, expenses, and features to be implemented.
You also need skilled technical writers who can translate broad requirements into smaller, more sub-projects defining detailed requirements and packages in order to reduce uncertainty and related risks in the project.
Resistance to Agile Contract Management
Agile is about mindset. In traditional industries this means changing mindset and the culture change needed. And traditional managers traditionally don’t like change.
What makes agile difficult for some managers is that it’s not just a new methodology or process that can be implemented within a firm’s existing parameters.
The agile way of running an organization is very different from the way we have been organizing ourselves since the Industrial Revolution that started over two hundred years ago. The top-down machine-like model with a strong focus on predictability, process and procedure and management extracting value from the firm, is being replaced by a new agile model that focuses more on people and capabilities, transparency and continuous improvement.
Agile focuses on people continuously innovating and adding value to the customers. Not working faster or more efficiently, but smarter and generating value for all parties (you, customers, society) sooner with less work needed.
Agile is all about a growing, experimenting, learning, adapting in a constant flow exploring new opportunities and adding new value for customers and your own company.
To achieve success, those doing the work must be given autonomy to self-organize and lead teams within broad parameters of control.
And it are not only the software developers, engineers or R&D people doing this. You need all parts of the organization working agile how to add more value to customers.
This includes your lawyers, but also your commercial and contract managers working with customers, subcontractors and vendors.
You may wants to start looking into agile contracting for your more complex and long projects.
There are three main types of agile contract:
- Capped Time and Materials Contract that protect the customer from paying too much if more time or materials are needed
- Target Cost Contract that works with pain-gain sharing incentives for parties to work more efficiently
- Incremental Delivery Contract that allow parties to brak up long and complex projects into smaller sub-projects to improve value and better manage risk.
To work with agile contracts you and your organisation need to fulfill some conditions:
- Change of mindset and culture from traditional ways of working to agile methodologies
- Willingness to collaborate
- From exploitation and extracting value to exploring new opportunities, continuous improvement and adding value to
Therefore, resistance can be expected from management but also from lawyers and contract managers who gave been educated in traditional law and contracting models that have been applied over the past two millennia.
So, my advise is, for your next complex project with a trusted customer, convince all people involved in the contract lifecycle to ‘just do it’ and see whether the benefits coming out of the project in the end will convince the most skeptical of your colleagues! And if you need our help, please contact me (see phone icon in top bar right).
Please leave comments below or – if that’s the case – tell me what experience you already have with agile contract management.
See more information here in the following resources I consulted when writing this post:
- Manifesto for Agile Software Development (2001) – the official Agile Manifesto website
- Forbes (2013): What is Agile? – if you want a quick background on what the agile method is
- Wikipedia: Agile Contracts – agile contracts according to Wikipedia
- Villanova University (2020) – What is Agile Contract Management?
- Medium (2017) – Agile Contracting by PMPeople