A SPECIALLY COMMISSIONED REPORT PROJECT RISK MANAGEMENT THE COMMERCIAL DIMENSION Tim Boyce THOROGOOD PROFESSIONAL INSIGHTS THOROGOOD PROFESSIONAL INSIGHTS A SPECIALLY COMMISSIONED REPORT PROJECT RISK MANAGEMENT THE COMMERCIAL DIMENSION Tim Boyce Published by Thorogood 10-12 Rivington Street London EC2A 3DU. t: 020 7749 4748 f: 020 7729 6110 e: info@thorogood.ws w: www.thorogood.ws © Tim Boyce 2003 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, photocopying, recording or otherwise, without the prior permission of the publisher. This Report is sold subject to the condition that it shall not, by way of trade or otherwise, be lent, re-sold, hired out or otherwise circulated without the publisher’s prior consent in any form of binding or cover other than in which it is published and without a similar condition including this condition being imposed upon the subsequent purchaser. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by the author or publisher. A CIP catalogue record for this Report is available from the British Library. ISBN 1 85418 257 9 Printed in Great Britain by printflow.com Other Thorogood Professional Insights Techniques of Structuring and Drafting Commercial Contracts Robert Ribeiro Successful Competitive Tendering Jeff Woodhams The Legal Protection of Databases Simon Chalton The Internet and E-Commerce Peter Carey Technical Aspects of Business Leases Malcolm Dowden The Commercial Exploitation of Intellectual Property Rights by Licensing Charles D. DesForges The Competition Act – Practical Advice and Guidance Susan Singleton Special discounts for bulk quantities of Thorogood books are available to corporations, institutions, associations and other organisations. For more information contact Thorogood by telephone on 020 7749 4748, by fax on 020 7729 6110, or e-mail us: info@thorogood.ws The author Tim Boyce began his career in the Ministry of Defence holding executive positions in contracts, contracts policy and finance. His industrial career began at Plessey in 1980 after which he enjoyed appointments with Siemens, British Aerospace and more recently as commercial director at BAE SYSTEMS. His functional responsibilities have included contracts, commercial, procurement, estimating, legal, project accounting and the implementation of the European Business Excel- lence Model. His committee work includes the Chartered Institute of Purchasing and Supply National Contracts Management Committee, the CBI Contracts Panel, the CBI Defence Procurement Panel and the CBI/MoD working groups on partnering and incentive contracting. He was the CBI observer at the HM Treasury Central Unit on Purchasing working group on incentivising industry. In 1997 he was invited by the Director General of the CBI to join the CBI Public Private Partner- ship Forum. He has lectured widely in the UK and in the US on business, contract and commercial management. THOROGOOD PROFESSIONAL INSIGHTS Contents 1 TOTAL RISK MANAGEMENT 1 2 GETTING TO CONTRACT 8 1. The risk – risk scenario 9 2. The bid/no bid decision 9 3. Bidding 16 4. Pricing for risk 19 5. Risk review board 23 6. Making an offer 25 7. The priced list of risks 29 8. The caveats register 30 9. An effective contract 31 10. Negotiation 34 11. Contract launch 35 12. Pointers for project risk management 36 Checklist 36 3 FINANCIAL RISK 38 1. Prime contract financial risk 39 2. The nature of price and the sharing of cost risk 39 3. The client will not pay 43 4. The client cannot pay 46 5. Inflationary cost increases 46 6. Foreign currency fluctuations 48 7. Contract termination 51 8. Financial claims against the prime contractor 53 9. Pointers for project risk management 54 Checklist 55 4 TECHNICAL RISK 58 1. Do we want to take this risk? 59 2. Analysing the requirement 60 3. Options 60 4. Sharing the risk 61 5. The commercial engineer 62 6. Setting the baseline 63 7. Requirement creep 64 8. The changing requirement 65 9. The work takes longer than expected 66 10. The never-ending contract 68 11. Failure of performance 69 12. Buyer initiated problems 70 13. Pointers for project risk management 71 Checklist 72 5 TIMEFRAME RISK 74 1. Bidding compliant delivery 75 2. The timeframe obligation 78 3. Time is of the essence 79 4. Consequences of delay 79 5. Liquidated damages 81 6. Force majeure 81 7. Delivery incentives 83 8. Client delay 84 9. Subcontractor delay 86 10. Prime contractor delay 86 11. The threat of termination 88 12. The threat of damages 89 13. Pointers for project risk management 91 Checklist 92 THOROGOOD PROFESSIONAL INSIGHTS 6 SUBCONTRACTOR RISK 95 1. For the want of a nail 96 2. Subcontracting: Benefit, risk and strategy 97 3. Subcontractor lateness 104 4. Subcontractor failure 105 5. Subcontractor work unfit 106 6. Monitoring subcontractors 106 7. Pointers for project risk management 107 Checklist 108 7 PROJECT COMPLETION AND BEYOND 113 1. Life after completion 114 2. Key contractual milestones 114 3. Residual obligations and risks 117 5. Acceptance 118 6. Products rejected 120 7. Title does not pass 121 8. Products lost or damaged in transit 122 9. Failure after delivery/acceptance 122 10. Warranty 123 11. The hand over of technical data to the client 125 12. Third party intellectual property rights 127 13. Account management 129 14. Pointers for project risk management 130 Checklist 131 THOROGOOD PROFESSIONAL INSIGHTS Section 1 Total risk management THOROGOOD PROFESSIONAL INSIGHTS Section 1 Total risk management The basis of all business is buying and selling goods or services or a combina- tion of the two. The word product is these days used for both goods and services. A television is a product and a particular type of insurance scheme may be described by the provider as a product. For the purposes of this Report the word product will be used in the former sense. Products are designed and produced and sold to customers as end items in themselves. The characteristics of a product might include: it is available off-the-shelf; it is produced (hardware) or replicated (software) in quantity with each unit being identical to every other; the design is driven by the supplier (albeit aimed at specific markets) rather than by an individual customer; the performance characteristics are well known prior to the product being made available to customers; its constituent parts are readily available as materials or components. On the other hand there is a particular type of service which is called a project. It commonly comprises the bringing together of many disparate products into an overall solution. The characteristics might include that it is bespoke; it is unique; the design is driven by one customer; performance characteristics can be designed and modelled but not known until the project is complete; its constituent parts may comprise products which themselves must be specially designed. Projects tend to be of large financial size and long timescale. Whilst no business enter- prise is without risk, it can be seen quite readily that projects are by their very nature of considerably greater risk than products. Management of risk in a projects environment is therefore of considerable importance. Project Risk Management is a well established doctrine supported by many tools and techniques. Risk analysis, risk registers, risk models and active risk manage- ment are all important in seeking that ultimate goal of project management – completion on time, to specification and within budget. There is, however, another key distinction between products and projects, the significance of which is perhaps sometimes overlooked. Products tend to be bought or sold subject to standard terms of contract. The buyer or seller, usually whichever is in the stronger position, subjects the transaction to his standard terms. In a percentage of cases there may be some negotiation of these terms, but frequently not. Conversely the prime contract terms for a project are invariably negotiated, specially drafted and often of significant contention before the parties come to agreement. Each side may come to the negotiation armed with a preferred set 2 THOROGOOD PROFESSIONAL INSIGHTS of terms, some or all of which may be based upon standard terms. Each will try to exploit the strength of its bargaining position to secure its terms but ultimately the agreed terms will always be of a bespoke nature, reflecting not only the outcome of commercial negotiations but in many instances reflecting the fact that individual standard terms may simply not exist or may be inade- quate for the unique situation of the particular project. Interestingly the choice between buyer and seller standard terms in a routine product transaction is fraught with danger for the side that concedes, for the simple reason that standard terms are never generated with fairness or balance in mind. The reason that every transacting organisation has different standard terms for sale and for purchase is that each organisation expects to purchase from its suppliers on terms which it would ideally never confer on its customers and vice versa. The central reason is that each organisation likes to both buy and sell at zero or minimum risk to itself. Standard terms are a means of pushing risk ‘down’ to suppliers and ‘up’ to customers. Everyone in the supply chain has the same motive. Of course in simple product transactions little attention is given because nobody expects anything to go wrong. The product is identified by part number or catalogue number, specifications exist, and price and payment are straightforward. The client gets what he is expecting and the supplier gets his money. The allocation of risk under the contract terms is of no practical interest other than in the very small percentage of cases where things do go wrong. Projects are different. It is not so much that the parties expect things to go wrong (if they did, they have no business in proceeding) but that they are aware that the risk of difficulty is inherently much higher. Not only are there usually more risks but several of the risks may have a significant probability of arising and the impact of a risk that materialises may be catastrophic. This results in two things. Firstly, each side (preferably jointly) will consider how best to manage the project so that risks do not materialise at all or, if they do, that the impact is minimised. Secondly great attention is given to the negotiation of bespoke contract terms. The contract is ultimately the single vehicle by which risks are allocated (or shared) between the parties. It is essential that each party knows where it stands both before a final decision is made to enter into the contract and afterwards, if risks materialise. A project management plan may ascribe responsibilities between the parties. A risk management plan may purport to allocate individual risks to one party or the other but the contract must be clear on what these allocations mean from a legal perspective. This is not just a point of technicality. For example, if the client agrees to carry responsibility for a particular risk (which affects the proba- bility of timely completion of the project) and to undertake risk mitigation activities, 1 TOTAL RISK MANAGEMENT 3 THOROGOOD PROFESSIONAL INSIGHTS [...]... helping the project towards a successful conclusion Putting these things together we are inevitably drawn to the fact that risk identification must inform the prime contract negotiations and the prime contract must inform the management of risk during project execution Understanding between project or risk managers (doing the job) and business or commercial managers (doing the prime contract) is therefore... therefore essential In fact the combination of project risk management and commercial risk management might be called Total Risk Management: TECHNICAL RISK MANAGEMENT COMMERCIAL RISK MANAGEMENT TOTAL RISK MANAGEMENT It worked We got paid Happy company We finished it We didn’t get sued Happy customer Cost within budget We made a profit Happy shareholders Figure 1: Total Risk Management THOROGOOD PROFESSIONAL... launch 12 Pointers for project risk management Checklist Section 2 Getting to contract 1 The risk – risk scenario Bidding for a contract involves a twin risk Firstly there is the risk of losing the competition and secondly there is the risk of winning it! As has been said before now, the good news is that we’ve won the competition, the bad news is that now we have got to perform the contract’ In any... undertake risk analysis during the bid stage only in respect of the second question This is to deny to the fundamentally important first question the benefits of risk analysis and risk management Consider these issues presented somewhat differently: Can we win? Bid risk management CONTRACT NEGOTIATION Can we perform? Pre-contract project risk management Request for bids received Bid submitted Project risk management. .. consider when the relationship between project risk management and commercial risk management of a project really begins The two facets certainly come together at the prime contract negotiation stage, but in many ways that is already too late There are four key points when the coming together must occur: TRM STAGES THE KEY QUESTION Bid/no bid decision What is the probability of submitting the winning... Commenting on a risk at the bid stage is theoretically the right thing to do because it exposes the issue early on and shows the client how thoroughly the prime contractor has understood the potential prime contract and the lengths to which it has gone to respond realistically On the other hand it may count against the prime contractor when the client adjudicates all the bids To eliminate the risk of a caveat... risks enshrined in the prime contract The form of contract may represent a simple allocation of risks – i.e it is a record of which party owns each risk and the consequences of that ownership Alternatively, the form of contract may in itself be constructed so as to deal with risk in a way that encourages client and prime contractor to cooperate in the management of risk Project risk management is the. .. management Contract awarded Project completed Figure 3: Risk Management Transition In the pre-contract stage two risk management activities should be underway One looks at the problems associated with preparing an attractive bid on time and defeating the opposition The other is concerned with predicting whether or not the project can be completed successfully Naturally if the early work on the latter question... to carry the risk Emerging from these considerations is the idea that the prime contractor could put forward a priced list of risks as options for the client to consider All companies are used to offering options that would have the effect of altering the cost, scale, performance and timescale of the project but the concept of offering risk options is one that should be given some thought The risk options... failure, then that result could have a devastating effect on the desire to bid and bid risk management would become superfluous In this diagram it has been convenient to introduce the expression bid risk management but preparing a bid for a project is in fact another project So it would be more accurate to say that the prime contract negotiation is the transition from one (bidding) project to another (doing) . is therefore essen- tial. In fact the combination of project risk management and commercial risk management might be called Total Risk Management: Figure 1: Total Risk Management TECHNICAL RISK MANAGEMENT It. REPORT PROJECT RISK MANAGEMENT THE COMMERCIAL DIMENSION Tim Boyce THOROGOOD PROFESSIONAL INSIGHTS THOROGOOD PROFESSIONAL INSIGHTS A SPECIALLY COMMISSIONED REPORT PROJECT RISK MANAGEMENT THE COMMERCIAL. another (doing) project and that project risk management in tandem with commercial risk management are needed in both stages. Can we win? Bid risk management Can we perform? Pre-contract project