CONTRACT RISKS

INTRODUCTION

In any one contract, it is advisable to focus where the risks are greatest. It is proper to identify the following:

- Risks associated with the supply market.

- Risks associated with the supplier.
- Specific risks the buyer wants to protect himself against, e.g. through terms and conditions.

TYPES OF RISKS

Time/schedule risks: These are delays occurring especially when an activity n which many others are dependent. Causes for such
delays include:

 Incomplete or incorrect specification.

 Delays in supplier’s inputs.
 Official bureaucracy.
 Poor communication.
 Supplier having insufficient resources, e.g. money, manpower and materials. This might have been caused by supplier
having underestimated the resource needed, supplier being very busy and diverts resources to other work and supplier’s
workers going on industrial strike.
 Production problems – supplier’s systems or production system may fail.
 Risk of mistakes – supplier’s personnel may simply make mistakes.
 Quality problems - a critical path component may fail quality test leading to rework. Indeed, quality problems are likely
when technology is new and unproven and when the supplier uses new supplier.
 Shipment problems – these may be caused by trade suspension because of war or trade sanctions, delays in obtaining
export/import licenses, strikes or other individual actions, natural disasters and theft in transit.

Cost risks: The basis against which cost risks are assessed is the contract budget. It is very important to assess cost risks if
- Cost is identified as high priority compared to time and quality.
- Contract has been paced on cost plus or reimbursable basis.

The most common risks are as follows:

 Incomplete or incorrect specifications by buyer, leading to more costs. Causes include unexpected event may occur,
underestimation of costs by supplier and supplier having acted upon many request by the buyer not covered by the contract.
 Adverse movement in exchange rates.
 Inflation.
 Increase in custom duty, transport charges etc.

Quality risks: Quality plan is the basis against which quality risks are assessed. It is particularly important to assess quality risks
when
- Quality has been assessed as a high priority
- Supplier has not been used before or for this type or contract
- Supplier is using new suppliers or critical components
- Technology or materials are being used are new

Quality risks include

 Incomplete/incorrect specifications: These will have impact on quality such as product failure, component will not fit, if all
equipment operating modes were not identified in the specification, equipment operators may find it difficult or impossible
to undertake certain risks.
 Inadequate/incorrectly undertaken testing and inspection: This results in defects being undetected until equipment is
delivered or put into service.
 Damage in transit: If goods are fragile and not properly labelled or mishandled, they may not be fully functional upon
receipt.

Commercial and other risks: These are caused by

 Lack of commercial awareness: When there are many channels of communication, there is a risk of the buyer’s personnel
making statement which compromise the buyer’s position. It is, therefore, important the personnel are sufficiently aware so
that communication is appropriate.
 Supplier suffers from financial problems: Cash flow problems may make him fail to pay for his supplies etc.
 Change of supplier ownership or change of key supplier personnel: Change of ownership may bring in new management
style which may no be good to the buyer. Changes in key personnel can create a problem in relationship. When a supplier
is acquired or merges with another, delays may be caused.
 Responsiveness: Responsiveness of supplier in terms of getting qualified personnel e.g. on site is very important. The risk
relates to the capability as well as availability of field personnel when installation and commissioning of equipment is
needed.
 Force majeure: Risks under this category include extreme weather conditions, flood, landslide, earthquake, fire, crashing
aircraft, war, revolution, riot, disease, insurrection, hijack and piracy.

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CONTRACT RISK REGISTER

All the risks one needs to be aware of during the contract implementation need to be described in a risk register to reflect changes in
risk as the contract progresses. The register should include
 Description of the risk
 Factors that could cause the risk
 The stage in the contract when it could occur
 Classification of the likelihood that the risk could occur
 Estimate of the impact on the contract performance in terms of time, cost and quality if the risk occurs
 An indication as to who is responsible for managing the risk (this should be a named individual).
 The risk management strategy, how the risk is to be prevented or its effects minimised, e.g. insurance, frequent expediting,
additional inspection etc. Risk management strategy should include contingency plans.