Today, I want to dive into the essentials of framework agreements and explore the various types of contracts you might encounter. Understanding these concepts is crucial for navigating the tendering process effectively. We’ll break down the challenges of each contract type to help you make informed decisions. Stay tuned as we unravel the complexities of contracting in tenders.
Establishing the Framework
Before you begin, it’s important to establish which framework is assigned to the new opportunity. This can make a significant difference. If there’s an existing framework agreement between you and the customer, great. If not, you’ll need to establish generic terms and conditions for your cooperation.
A framework agreement is crucial because it sets out the general terms and conditions for your cooperation. If you don’t have a formal agreement with the customer, you’ll likely need to establish a separate framework agreement. This agreement acts like an umbrella, covering only the generic terms and conditions. Specific product orders or services are then ordered under these framework conditions, with additional specific terms for each product or service.
Key Elements of a Framework Agreement
High-level conditions should be covered in the framework agreement, while more detailed conditions are included in statements of work, project agreements, or similar documents.
So, what kind of information should be included in a framework agreement? Let’s start with definitions. If you’re in a specific business environment, you can establish a definitions table to ensure all parties have the same understanding of certain terms.
If you’ve worked with the customer before, you might include information about any pre-existing agreements and how the new framework agreement will influence them. You can specify whether the new agreement will overrule existing ones or not.
Next, you might create a service catalog, which is a structured document listing the services available under the umbrella agreement. This catalog is updated each time you sign additional agreements with the customer.
You should also describe the process for ordering services under the framework agreement. Establish a standard service management and governance model, so you don’t need separate agreements for each service.
Include information on how you will handle acceptance, delays, licenses, and intellectual property rights for the provided services or products. Generic information about service levels should also be covered, including cross-functional service levels that apply to all services.
List the communication and reporting procedures, making them common for all services. Outline the change request procedure and customer responsibilities. Include information on warranties and indemnification.
A very important topic is remuneration and payment terms. If you agree on a 60-day payment term for the framework agreement, remember that your invoices will be paid 60 days after the invoice date, which can affect your cash flow.
Finally, cover data protection, privacy, information security, audit rights, terms and termination, and legal topics like property rights, confidentiality, corporate responsibility, export control, applicable law, and dispute resolution. Don’t forget to include a list of annexes.
Impact of Framework Conditions
That’s a lot of conditions we’ve covered, and they can significantly impact both the customer and the supplier. How these conditions are formulated can affect future services. So, think carefully each time to find the best solution for you and your customer.
Establishing Contractual Bases
Now, we need to establish our contractual base for separate services. Usually, we might have a project agreement, which details the scope, objectives, and responsibilities for a specific project. Project agreements are typically for projects with a defined start and finish date, within which they should provide value.
Another type of agreement you can establish is a service agreement under the framework agreement. This kind of agreement specifies the services you will be providing, how you will provide them, and the service levels and performance metrics to be considered. The main difference is that a service agreement is related to recurring services. For example, if you provide maintenance for an application on a monthly basis, that would fall under a service agreement. On the other hand, a project agreement would be used when developing an application, and the project would likely finish once the final application is delivered to the customer.
A smaller type of agreement is a call-off contract, which is used for smaller orders or specific goods provided to the customer. Purchase orders are formal requests from the customer to the supplier to provide goods or services. These include details such as quantities, prices, and delivery dates.
Depending on the customer and the services or products you are providing, this contractual library can be very complex. In complex situations, you might have a framework agreement under which you have a project agreement, sometimes called a portfolio agreement. Under the portfolio agreement, you might have multiple statements of work related to separate projects, each with specific annexes.
You might also have service agreements under the framework agreement, with multiple service agreements for different services. For example, you might have a service agreement for SAP applications, under which you have multiple service agreements for different landscapes. Similarly, you might have a service agreement for digital workplace solutions, with only one service agreement for the digital workplace.
Finding where you are and to which contractual place your opportunity fits is a key topic that should be covered early in the tendering process.
Specific Contracts Types
Now, let’s move on to specific contracts related to payment terms. As you remember, the generic payment and financial terms are established at the framework level. For each service, product, or project, we establish specific financial models.
Fixed-Price Contracts
Starting with the most common type, the fixed-price contract. In this type of contract, the price is clearly defined for the delivery scope and agreed upon by both parties. This price should not change unless formally approved by both parties.
One of the main advantages for the customer is cost predictability. However, there are potential downsides. The supplier might use cheaper materials or less qualified staff to meet the agreed budget, which could lead to lower quality. Additionally, if the fixed price isn’t a great deal for the supplier, they might not prioritize the project, potentially causing delays.
On the other hand, if the supplier underestimated the budget and can’t legally change the fixed price, they might push the customer to trigger a change order, which could result in additional costs for the deliverables.
In practice, it’s clear that most of the risks lie with the supplier. These risks might include unplanned additional work required to deliver the scope, unforeseen issues, underestimation of effort or materials needed, and challenging building environments. It’s quite common to underestimate the competition as well.
There might also be a need for rework due to incorrect design solutions, changing market conditions like inflation, currency rates, and prices of raw materials. Poor project management can lead to lower performance than expected.
If this kind of contract is based on a good partnership, both parties should be happy with the agreed terms. Customers should be satisfied with the price, and suppliers should be content with the terms and conditions, which should align with common standards.
There are some variations of the fixed-price contract. One variation is the fixed-price incentive fee contract. This type includes a bonus based on objectively measurable indicators, such as delivery time or quality metrics. It can be used when the customer benefits from improved performance covered by the incentive fee. For example, if a contract is scheduled to last 12 months, but faster delivery allows the customer to utilize the services sooner, the supplier might receive a bonus for early completion.
Another type of fixed-price contract is the fixed-price award fee. In this case, the bonus is subjective. The customer may choose to pay the supplier an additional bonus based on their satisfaction with the work, or they may not.
Cost-Plus Contracts
Next, let’s talk about cost-plus contracts. These are used when suppliers want to avoid the risks associated with material costs or when the customer seeks complete transparency over expenses. They are popular in the construction industry, where materials are significant cost factors. Smaller subcontractors often prefer to transfer this risk to the customer.
As always, these contracts come with their own set of risks and should be used carefully to avoid unexpected surprises. The basic definition of a cost-plus contract is that the supplier has all costs reimbursed by the customer, along with an agreed-upon fee for the work.
For example, if someone is painting your house, as the customer, you would cover all the expenses such as paint, brushes, protective foil, and so on. Additionally, you would pay a predetermined fee for the painting service itself.
What are the risks for the customer? They might underestimate the quantity of materials or equipment required, leading to higher costs. Unforeseen costs can arise, like additional materials needed. Market price increases for materials or equipment can also impact the budget.
For the supplier, the fee may not cover additional work if the task requires extra effort. The customer may not reimburse certain costs if they weren’t previously agreed upon. For instance, if the supplier didn’t mention that brushes were needed, the customer might refuse to cover their cost. If the supplier isn’t cost-conscious and expenses escalate, the customer might seek to terminate the contract, which could negatively impact the supplier’s reputation.
In these types of contracts, we might also add incentive price adjustments. This could include an incentive fee based on objective indicators, like delivery time or quality metrics, or a subjective indicator, like an additional bonus.
Time and Material Contracts
Last but not least, let’s talk about time and material contracts. These are popular for their flexibility, making them a common choice for consulting firms, research and development, IT companies, and IT projects. This type of contract charges based on the actual amount of time spent, rather than a flat rate for a predefined scope.
This flexibility comes with risks if not carefully managed. The supplier may unnecessarily extend the hours, leading to additional costs that could compromise the project’s financial viability. In general, with time and material contracts, clients pay a set rate for labor, typically calculated by the hour or day, and for direct expenses like materials. The labor rate includes the supplier’s margin, ensuring their profit.
For example, if you hire a consultant, you would pay them an hourly rate for their work, plus additional direct expenses related to the task, such as travel and accommodation.
These types of contracts are usually a good fit for agile environments, where the exact outcome isn’t known from the start.
So, what are the risks for the customer? Typical risks include cost increases due to a lack of clear vision and project ownership, leading to continuous reworks. There might be inadequate control over the work delivered by the supplier due to a lack of transparency and an absence of proactive risk management, resulting in substantial additional work.
For the supplier, risks include the possibility that the customer can terminate the contract early, possibly before the supplier recovers their costs. Overhead costs, such as sales expenses, can escalate. If costs increase and the customer feels overcharged, it could result in contract termination and damage to the supplier’s reputation.
In any type of contract, a good relationship between the supplier and the customer is crucial for finding a win-win solution. Problems arise when one party tries to take advantage of the other, which isn’t a true partnership.
To mitigate risks related to additional work and cost escalation, you can use target cost contracts. Set a threshold value for when the contract will finish and what value should be delivered by that time. This can be measured to see if the value was reached and if the project vision was maintained.
Another approach is incremental delivery contracts. Instead of charging per hour, you can set increments. For example, if you have a team working in sprints, you can charge the customer per sprint. After each sprint, you might have a demo of the solution or product, and the customer can decide whether to continue or stop based on the progress.
Conclusion
Navigating the complexities of framework agreements and various contract types is essential for successful tendering. Framework agreements set the stage by defining general terms and conditions, while specific contracts like fixed-price, cost-plus, and time and material agreements address the unique needs of each project or service. Understanding the benefits and risks associated with each contract type helps in making informed decisions and managing potential challenges effectively.
A well-structured framework agreement acts as an umbrella, ensuring that all parties have a clear understanding of their roles and responsibilities. This clarity is crucial for maintaining a good relationship between the supplier and the customer, which is the foundation of any successful partnership. By carefully considering the terms and conditions, and choosing the right type of contract for each situation, you can create a win-win scenario for both parties.
Remember, the goal is to find solutions that benefit both the customer and the supplier. This requires open communication, transparency, and a willingness to adapt to changing circumstances. By doing so, you can navigate the tendering process with confidence and achieve successful outcomes for all involved.
