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Selecting Contract Type for Outsourced Software Development Project

Selecting Contract Type for Outsourced Software Development Project

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Published by: xonstance on May 12, 2012
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Selecting Contract Type for Outsourced Software Development Project
John ConstanceMSc in Project Management, University of Liverpool
The best way to ensure a buyer receives the desired goods and services from the seller isthrough a contract agreement. Contract obligates the seller to provide specified procurementrequirements 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 today’s business environment can obstruct or reduce theparties’ ability to produce contract requirements. Changes in market conditions; and industrialregulations 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 sureto determine all the conditions surrounding the procurement and select the contract type best fitand 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 sellerto perform most effectively; but that through its terms and condition there is maintained sharedclient-contractor relationship and collaboration.
While it is fair to say majority of day-to-day procurement transactions are conducted in straightforward one day activity in a stable and certain environment or arrangement; there are severalother goods and service purchases that go beyond a day’s event and conducted in very harshand uncertain business environment.To get a seller to provide particular services to a buyer, such conditions require a buyer-sellercontract. Contracts are legally binding documents used by the project owner and the contractorto provide contract services. The contract all ensures all expected uncertainties and changes thatmay impact the seller’s ability to legally fulfill its agreed performance are taken into considerationunder the contract with provisions to manage such situation.There are several contract types that can be satisfactorily used to ensure all parties have theability to perform their side of the arrangement. The project manager must determine conditionsurrounding the business market, industry, terrain and weather and the uncertainties associatedwith these conditions and select the contract type that will best manage to successfully procurethe required project items and deliver of the goals of each party.This paper will examine the contract type required to manage a software development projectthat is within an unstable and changing business environment that can significantly impact thespecifications and requirements of the project throughout its entire life. The various contracttypes will be briefly defined and the most appropriate and best-fit contract type for this projectand business condition will be recommended. Reasons for the selection of this contract type willbe provided and the conclusion will show this contract type is best fit to manage projects thatwill 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 muchof 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 aboutseeking 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). Theauthor goes on to explain the problems encountered during OSD.
Information confidentiality uncertainty – provision of total security is difficult to foretelland prevent
Staff proximity – lacking constant and easy access to staff creates excessive managementand technical overhead and decreases product quality
Financial payback uncertainty - client uncertainty in product payback can due tobankruptcy, legislative changes, political instability, etc.
Management complexity - a lack of firm control on operations
Lack of control – no control over the outsourced resourcesSubhankar Dhar, Bindu Balakrishnan (2006) of San Jose State University in the USA identifiedseveral risks associated with OSD. These include people, knowledge, culture, politics, finance,quality standards, measurement, scope, cost, time, legal contracts, intellectual property, disasterrecovery, contract management, geographic location, relationship and alliances and companyspecific risks. All these indicate that no matter the environment there is always the possibility that an OSDproject 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 certainspecified services or works and another party to pay for the provision of the specified services orworks. 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 situationsPMBOK (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 contractor’s actual cost
it persuades the contractor to control costs
there are three types of Fixed-price contract (PMBOK, 2008)
Firm fixed price (FPP):
precise, fixed price for a detailed described deliverable;
good to use when the level of uncertainty is low
Fixed price incentive fee (FPIF
allows flexibility in performance deviation,provides financial inducement for achievement of agreed requirements; used tonegotiate a specified cost, and profit and maximum price for risk allocation; therisk 
is that the buyer will most of the time pay the seller for delivery of optimalproject outcome
Fixed price with economic price adjustment (FP-EPA): allows price adjustmentbased on agreed contingency factors not under the contractor’s control;
and isused to protect the parties against major economic unpredictables including costsfor labor or material
Cost-reimbursable contracts
 According to Langford (2007) this contract type is more suitable where transactionaluncertainties is expected to affect the contractor’s performance, delivery timetable, andtotal project costs
Heldman (2009) said this contract as one that the buyer is charged to pay all contractedcosts incurred by the seller
there are three types cost-reimbursable contracts (PMBOK, 2008)
Cost plus fixed fee (CPFF):
allows the seller to recover actual costs; and when thecontract is completed the contractors receives an additional fee agreed by bothparties; and used when uncertainties involved in the performance of the contractis sufficient to prevent the use of the fixed price contract
Cost plus incentive fee (CPIF):
allows the contractor to recover actual costs; andwhen the contractor exceeds a specified performance a bonus fee agreed by bothparties is paid to the contractor; and used to encourage the seller to improve costsavings and performance and achieve greater profits
Cost plus award fee (CPAF):
allows the contractor to receive all actual costs plusthe payment of an award fee base solely on the judgment of the buyer; and usedwhen additional incentive is required to ensure the seller achieves excellence inquality, time, techniques, and costTime and materials contracts
payment made to the contractor based on actual cost of direct labor, materials andequipment usage, and a fixed add-on cost tocoveroverheads andprofit
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

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