Is your contract strategy suitable for your circumstances?

Question:  Does your contract strategy suit the risks you are trying to manage in your supply chain or with your supplier / partner?

A traditional ‘Risk Transfer’ arrangement for project or service delivery contracts is still the primary approach for many industries in New Zealand.  But there have been huge changes to the way organisations work together over the last 20 or 30 years due to changes in technology and other operating environment factors. So risks are increasingly unpredictable and it cannot be said that risk transfer is always the right approach. A contract owner must choose a contracting model that is appropriate to the particular circumstances of the project or delivery of service (work as done) and I believe there will be an increasing need for partnership contract approaches in the future. 

Partnership contracting is not a new concept. 

• The construction industries of Australia and New Zealand have been operating 'Alliance' partnerships for large infrastructure projects since the late 1990's. From this origin, further alliances models have been extended to manage large scale utilities services and for the delivery of health services. 

• In an entirely different industry and at a different scale, a partnership form of contract is promoted within the SAFe Agile model for Agile technology project delivery (https://www.scaledagileframework.com/agile-contracts/). 

Even though partnership contracting is not new a risk transfer form of contract is still the most common form of agreement. As technology continues to evolve and becomes and the way organisations work together more inter-connected, and I believe there is considerable growth potential in partnership contracts and corresponding working relationships.

Lets explore further.

All services or projects involve inherent risks (eg. political or economic change, climate, technology, ground conditions, engineering uncertainties, errors, industrial disputes, land issues, environmental issues and many more).  When entering arrangements to undertake high risk services or projects with other organisations a risk owner must select the most appropriate contract strategy for managing the sorts of risks that are present to effectively consult, communicate and coordinate.

The traditional approach to contracting where risk is transferred over to a supplier, is still the most common method for many supply chain contracts.  This method has been proven over many years to be particularly effective when the scope is clear and the circumstances and risks are reasonably predictable.

However, more and more projects and services have to be delivered in an environment of increasing uncertainty.  This increase is driven by rapid technological change, corresponding social change, shifting business or political imperatives and diverse stakeholder interests.  The traditional simple risk-transfer contracting models have increasingly been shown to have limitations in dealing with these circumstances.

Work as imagined:

• All project or service risks can be effectively transferred out to contract suppliers just like they always have
• Organisations can effectively consult, coordinate and cooperate even with traditional risk transfer contracts that stipulate a separation of responsibilities and focus on individual needs.

Work as done:

• Project and service risks all different and are spread across a spectrum from predictable and stable to unpredictable and changing.
• Sometimes  supplier contracts can get in the way of effect consult, coordinate and cooperating.  Particularly when risk management requires a high degree of collaboration
• There is an increasing need for supply chain agreements that involve risk owners retaining and partnering on risk rather than simply transferring risk.

The following matrix is presented by Jim Ross in a 1998 paper on alliancing in the Australian construction industry.  It shows a strategic relationship for the suitability of a risk transfer approach vs a risk embrace approach depending on the circumstances.

Examples of: 

1. Full risk transfer: Traditional supplier contract 
2. Hybrid: supply chain collaboration forums, transparent workflow, cost + agreements etc etc.
3. Full risk embrace: Relationship contracts, e.g. - Joint Venture Construction project alliance, Health Service Alliance

There is no particular model along this spectrum is the “right” one for all situations. The model shows how a contract owner must choose a contracting model that is appropriate to the particular circumstances of the situation.