Thought for the day: The IT contracts hammer

Beware consequences of tough public sector contracts, says Roger Bickerstaff

Beware consequences of tough public sector contracts, says Roger Bickerstaff

Negotiations 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

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