Risk management is an important part of the project contracting process. Cooper (2005) positions contracts as a tool to help allocate or transfer risk in business transactions. The contract is intended as an “agreements between parties for the conduct of specific actions or functions, in return for consideration” (Cooper 162). Through a properly executed and managed contract, both the customer and its vendors are able to more effectively manage risks related to development projects.
Contracting Risks
The contracting process has some inherent risks. First, both the buyer and the seller must ensure risk is appropriately balanced between the parties. Unless there is a risk balance for the roles and responsibilities of the parties, one of the parties is taking on an imbalance that could negatively affect its business should there develop conflict in the relationship.
Ambiguity is another risk related to the contracting process. Ambiguity is the possibility for one or more of the parties to interpret information in more than one way. Lack of detailed requirements or unclear roles and responsibilities can create ambiguity between the parties.
In addition, the type of contract selected will impact risks associated with the contracting process. Huston (1996) identifies four primary types of contracts: fixed price, unit price, target price and reimbursable contracts. Each contract type has its strengths and weaknesses for both the buyer and the seller.
Resolving Contracting Risks
According to Cooper, the basic principle of the contracting process is to “allocate risk to the party best placed to manage it, through specific wording in the contract document” (Cooper 162). This approach is used to help develop balance between the contract parties. By clearly defining roles and responsibilities and determine which party is best suited to accomplish contract tasks, the parties are able to ensure the most qualified party is able to control the outcomes of its portion of the contract.
To address risks related to ambiguity, the parties must write the contract clearly so to minimize any confusion about the requirements of the work to be performed. As the clarity of requirements increases, the risk associated with misunderstanding and conflicts reduces. Some buyers might consider the extra work needed to develop clear requirements as lengthy and costly; however, the investment on the front end can greatly reduce the risk of conflict during contract execution.
The buyer and seller must select a contract type that best aligns risk with the responsibilities outlined in the contract. For example, a fixed price contract will provide the most cost risk management for the buyer but increases cost risk for the seller. In order to maintain a risk balance between the parties and to reduce ambiguity, the buyer must provide clearly defined requirements so that the seller is able to determine the costs associated with delivering to the buyers expectations.
Finally, the parties must ensure a process is in place to manage the contract relationship. Cooper says even a well written contract can fail if not managed appropriately. The parties should discuss, and if possible build into the contract, the processes and procedure to ensure successful management of the contract.
Works Cited
Cooper, D., Stephen, G., Raymond, G., & Walker, P. (2005). Project Risk Management Guidelines: Managing Risk in Large Projects and Complex Procurements. West Sussex: John Wiley & Sons Ltd.
Huston, C. L. (1996). Management of Project Procurement. The McGraw-Hill Companies, Inc.
No comments:
Post a Comment