Beware consequences of tough public sector contracts, says
Roger BickerstaffNegotiations on public sector IT contracts have become a
battleground. Recent major public sector IT projects have seen more
risks being transferred to the suppliers, and some of the larger IT
service providers have decided not to bid on billion-pound projects
on the basis of the required terms and conditions.
The Office of Government Commerce has issued a new set of draft
terms and conditions for central government IT projects. This
indicates that the OGC is adopting a different approach to risk
allocation.
The UK IT industry should take notice of this change. The terms of
IT contracts are not just a matter for lawyers to debate. IT
contracts can have a real impact on the nature of the development
of the UK IT industry. Inappropriate contract terms hinder rather
than promote successful project delivery and, as a result, the UK
IT industry in general.
An example is the OGC's position on milestone payments. The OGC
virtually prohibits making milestone payments during project
development. These will usually not be payable until operational
"go live" of the project. Even then, the profit relating to the
development phase will only be payable through service payments
over the lifetime of service delivery.
Learning the key lessons
At first sight this may appear to protect customers who will not
have to make payments until the project is delivered successfully.
However, one of the key lessons of IT projects funded through the
private finance initiative has been that they are more likely to
fail because of the financial pressures on suppliers through paying
for the development phase.
A different approach is taken in the US where small and
medium-sized enterprises are given preferential treatment in public
procurements. As a result, there is a pragmatic approach to
milestone payments. The US government recognises that financing
requirements would deter SME bidders. It also considers it is more
cost-effective for government to finance contract performance
rather than making the contractor borrow money.
Lawyers will always tend to see contract negotiation as a battle to
be won. Few lawyers consider the consequences of the positions they
adopt. Economists tend to look rather more at outcomes.
Dan Muldoom of specialist economics adviser Ecom has summarised the
position succinctly. He said the OGC's approach appears to be that
risks are necessarily best borne by suppliers where this is
possible, but he warned that this is an economically unjustifiable
approach. Muldoom said that from an economist's perspective the
efficient allocation of risk between parties to a contract should
depend on two main considerations:
- The relative costs of the various parties in bearing various
risks
- The extent that certain risks may be controllable by the
parties and are allocated in a way that gives parties appropriate
incentives.
Hurly-burly of negotiations
This is a more measured approach to the allocation of contract
risks than the usual hurly-burly of the contract negotiating table.
Contract negotiators should still take account of this message and
remember to think through the consequences of their negotiating
positions.
The UK IT industry should also think through why it is that central
government is taking a tougher line on IT contracts. It is not hard
to see that the change in the OGC's approach arises from the many
high-profile IT project failures. By stiffening the contract terms,
it appears that successful project completion will be encouraged as
project failure will be even more unattractive to suppliers.
Furthermore, the public sector will have enhanced redress when
projects go wrong.
Even though this approach must be questioned by the IT industry, it
looks as if the UK IT supplier community as a whole is not on-side
in promoting the government's aims in developing an e-enabled
economy. This is odd as the interests of IT suppliers and
government should coincide. The government wants to build a
knowledge-based economy and this must be good for the UK IT
supplier community.
Until public sector projects can be seen to be delivered regularly,
the pressures for stringent IT contract terms will continue.
Roger Bickerstaff is joint head of the international
information technology group at law firm Bird & Bird
