Enable javascript in your browser for better experience. Need to know to enable it? Go here.

Why there’s no such thing as a risk-free commercial agreement

This article is part of our Shared Values content series, which explores the foundations of impactful and sustainable public sector project partnerships.



Most public sector organizations rely on external providers for some level of support – from day-to-day to specialized services or business-critical initiatives. So how do you make sure you all agree on the scope of support – and its funding?


In 2020-21, the Australian Government published 84,054 contracts on their procurement information system, AusTender, with a combined value of $69.8 billion. Almost two-thirds of that value was assigned to digital products and services, which are often much more challenging to define and manage than physical goods.


Commercial models are an integral part of the procurement process; they are the framework that buyers and providers use to agree how to scope and fund a project or piece of work.


However, defining a good model that balances the needs of buyers and providers can be fraught with difficulty, especially as the speed of expected delivery increases and work itself becomes more complex. Buyers and providers often find it hard to agree on a suitable commercial model.


This article explores how to think about the challenges, overcome points of friction, and find some common ground to deliver value for citizens.



Competing needs of buyers and providers


At first glance, the needs of buyers seem diametrically opposed to those of providers. On the surface, one is out to save money, the other to make it.



The buyer’s mindset


Buyers typically prioritize peace of mind when engaging a provider – so it’s not uncommon to look for a product or service delivery at a set price. Their biggest fear is, “what happens if things go wrong during the project?”. So they seek assurance from the provider that they understand exactly what is required, and will deliver exactly what they have promised.



The provider’s dilemma


Providers also worry that things might go wrong. They know that the future is uncertain, and that even the best laid plans can come undone, especially as new information emerges through the course of delivery. 


Ethical providers want the best possible outcome for the buyer as well as themselves so they are more likely to seek the freedom and autonomy to change course if and when required. And ideally, they would like to share that risk with the buyer so both have skin in the game.


So while buyers and providers may appear to have competing needs, there are many ways in which they align:


  • Both understand that the future holds uncertainty

  • Both want the best outcome from the work 

  • Both worry that things might go wrong; and

  • Both want to reduce the risk of things going wrong.


These are good foundations on which to build a relationship based on trust. Decisions don’t need to be binary (win-lose) – they can be ‘ternary’ (win-win-win) where there's a win for both parties and a great outcome. Until someone creates a crystal ball, neither party can predict the future, and so the decisions made around commercial agreements need to accommodate that reality.



Myths and misconceptions


Despite having the best intentions, the process of negotiating a commercial model can come unstuck if either party believes in some common myths and misconceptions. It’s time to face reality with these four hard truths.



Myth 1: You can transfer risk of failure to another party


To effectively manage risk, you need to deal with the uncertainty of what might happen in the future. Whenever a decision is made, its outcome is not certain until it actually happens. For example, we make assumptions about the market, project plan accuracy, new product build feasibility, or the impact of processes under load. All of these assumptions carry some risk of being incorrect – with consequences for the project as a whole.


The truth is, risks are always with us – whether we know it or not. They will either be realized as issues we must address, or they will no longer matter after a particular point in time or event. Regardless, we have two choices: understand and do our best to manage the risks, or ignore them and potentially be blindsided by unforeseen problems.


The risk is always owned by the entity that stands to suffer the consequences of the risk, should it be realized. That’s why you can’t transfer your risk to another party. So it’s in our collective best interest to actively consider and manage risks, rather than attempt to hand them off.



Myth 2: Fixed pricing provides strong project control


Buyers may have an illusion of control when a fixed scope project is subject to fixed pricing (or 'not-to-exceed price'). They may feel a (false) sense of comfort knowing that ‘whatever happens, at least the project will not exceed our allocated budget.’


For providers, a fixed price model carries an implied threat; meet the fixed price, or else.


And therein lies the problem.


In reality, the future unfolds with uncertainty replaced by certainty, largely independent of whatever fixed price has been deemed an appropriate limit. And so, reality increasingly deviates from the hope or the vision that set the price, no matter how tightly we try to hang on to it.



Myth 3: With enough effort, upfront specifications will be right


Most product concepts fail. Clayton Christensen, a leading thinker in disruptive innovation at Harvard Business School, estimated the failure rate at 95% due to a lack of understanding of what customers really value.


Despite this, many organizations continue to waste significant investment in delivery by building and launching new digital products in the market without testing them with customers first. Not to mention the reputational risk to their brand. This is just as true for established platforms as it is for start-up ideas.


This does not mean ignoring user needs – quite the opposite. We could spend time asking customers what they want but, as Steve Jobs said, “Customers don’t know what they want until you show it to them.” If Apple had asked its customers, they never would have imagined an iPod was possible. And that’s why the only way to gain certainty about a product is to build a prototype and test it in the market.


We need to accept the reality that no matter how much effort is put into defining digital product specifications, it is likely a good proportion will be inaccurate or missing. An iterative ‘test and learn’ approach may feel less comfortable because it will feel like there is the potential for constant change as a result of testing feedback, but it is the only way to allow a product to evolve with learnings and the lowest possible risk.


And this is even more true with a disruptive product or service in a new market.



Myth 4: ‘Time and materials’ models give the provider all the power


Time and material contracts are often seen as the 'opposite' of the fixed price delivery model: the buyer will be billed for the actual work scope based on hourly rates of labor on a specific project, plus the cost of materials.


Some buyers believe this is essentially a money train for the provider, all aboard until it reaches the end of the line. As with the misconception that fixed price contracts provide control, this maxim is also more wrong than right.


Think of it this way instead. When employed correctly, time and materials can shift the focus away from the price of delivery to the value of what is delivered.


Instead of predicting the requirements, and applying a fixed price to delivery (in the hope it proves valuable), time and materials gives the buyer and the provider the flexibility to discover what will be the most valuable thing – and deliver that.


In fact, this approach can often save money. A project can be stopped when sufficient value is deemed to have been delivered. If priorities change, the delivery team simply shifts and refocuses, without the baggage of inflexible specifications and unachievable (or unnecessary) deliverables.


Ultimately, this reinforces the aligned goals of the buyer and the provider: to create something of value when so much is, initially, unknown. In the case of public sector funding for digital projects, establishing the right underlying commercial model to deliver that value, can in turn have a positive impact for our citizens, our society, and our economy.


As a principal consultant with Thoughtworks, Anthony O’Connell brings almost three decades’ experience in product engineering, business and product development, lean principles, and change management. He has led large, complex projects to develop and implement solutions to difficult problems, and specializes in the processes that contribute to successful innovation and change across the private and public sector. He is an accomplished teacher and speaker on all things value and waste.

Let's talk about your next project