One of the key characteristics of projects is their progressive elaboration nature. That means, when one gets into the project more, he will get to know more about the product. For projects where engineering discipline is not conducive to change like construction projects, the preferred contract type was always ‘fixed price’ and continues to be so.
Projects where requirements are continuously evolving and technology is fairly new are the right candidates for adopting agile (scrum), so that the value of the emerging requirements during project execution can be harnessed and converted to features which provide competitive advantage.
This calls for the need for ‘Agile contracting’ which will create win-wins for all the stakeholders involved especially the customer and the supplier.
Firm fixed price contracts and agile projects
In fixed price contracts very often the customer’s and the supplier’s interests are at loggerheads. The cost risk is maximum for the supplier. If the scope increases beyond the initially agreed upon scope, then the cost will also increase. This in turn creates lot of strain on the customer / supplier relationship. In agile projects, the supplier is supposed to work along with the customer throughout the development process and deliver maximum value. Because of these reasons, firm fixed price contracts are not a good choice for agile projects.
In this contract type, the scope is frozen and for completing the frozen scope a target price is fixed. On top of the target price, a profit margin for the supplier is also defined. If the supplier is able to complete the project without consuming the target price, then they will be eligible for the profit margin and for a percentage of the cost saved. If the project exceeds the target price, then the loss is shared among the customer and the supplier.
Target price contracts are better than firm fixed price contracts for agile projects because it is either win-win or lose-lose for both the customer and the supplier. Unfortunately in target price contracts, the scope is frozen upfront and additional scope will impact the target pricing.
Cost plus fixed fees
In cost plus contracts, the target scope is defined and the supplier is provided with the cost incurred plus a fixed fees. In Cost plus contracts, the supplier will never make a loss where as the customer can make a loss. Because of this it becomes more profitable for the supplier if they take more time to complete the project. This type of contract does not protect the customer from cost risk and will prevent them from adding new emerging requirements during the development process, ending up in sub-optimal products because of scope restrictions and conflicting interests.
Time and material contracts
The scope is open. The supplier gets paid based on the actual time spent on the project. This is very open hence scary because of the flexibility of having moving targets.
The ideal agile contracts must be open enough to collaborate without loosing control over the project cost and scope. The Minimum Viable Product (MVP) is frozen upfront and is operated with a ‘Target price’ contract. The additional features outside the MVP are operated with a Cost Plus contract. This provides amble flexibility to collaborate without loosing control.