Episode 181 – Contract Strategies – Ten Key Principles of Contracting

The podcast by project managers for project managers. Selecting contractors and negotiating the terms of a major project is one of the most difficult aspects of project management. In this episode Ed Merrow sheds light on fairness in contracting relationships, for the relationships to be self-enforcing, and how not to unwittingly set your contractors up to fail.  Table of Contents 02:53 … Meet Ed05:28 … Contract Strategies for Major Projects06:59 … Hiring Contractors is Never Easy07:55 … Key Principle #209:12 … #1 There is No Free Lunch10:20 … TINSTAAFL11:28 … #3 Complex Projects Need Simple Contracting Strategies13:03 … Collaboration15:07 … #4 Owners and Contractors are Different17:44 … #5 Large Risk Transfers are More Illusion than Reality19:25 … Importance of Scoping21:29 … #6 Contractors have Shareholders23:14 … Ren25:29 … #7 Contracting Games are Rough Sport27:05 … #8 Assigning a Risk to Someone Who Cannot Control that Risk is Foolish29:07 … #9 All Contracts are Incentivized33:20 … #10 Economize on The Need for Trust36:40 … The Value of Prequalifying Contractors40:13 … Getting the A-Team or the B-Team42:48 … Get in Touch with Ed44:02 … Closing ED MERROW: ...both owners and contractors play games.  Contractors usually win those games.  My advice is try to keep games out of your contracts.  Try not to put in a bunch of complex provisions whereby you think that the contractor will “have skin in the game.”  I want owners to remember that skin in the game is almost always owner skin.  WENDY GROUNDS:  You’re listening to Manage This.  This podcast is by project managers for project managers.  My name is Wendy Grounds, and with me in the studio are Bill Yates and Danny Brewer.  We love having you join us twice a month to be motivated and inspired by project stories, leadership lessons, as well as advice from industry experts from all around the world.  We want to bring you some support as you navigate your projects. 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Today our guest is Ed Merrow.  Ed is the founder, president, and CEO of Independent Project Analysis, the global industry leader in quantitative analysis and benchmarking of project management systems.  Ed received his degrees from Dartmouth College and Princeton University; and he began his career as an assistant professor at the University of California, Los Angeles.  He followed that with 14 years as a research scientist at the RAND Corporation, where he directed the Energy Research Program.  We’re talking to Ed particularly today about his most recent major research effort which is centered on the quantitative analysis of how contracting strategies and delivery systems shape project results.  His new book is on this subject, and it’s titled “Contract Strategies for Major Projects.” BILL YATES:  In our conversation with Ed on procurement and contract strategies, Ed is going to share with us the key principles of contracting that all those involved with planning and executing major projects should know.  Here are three things to listen out for on this episode.  One, contractors may make convenient scapegoats, but they are rarely to blame for bad projects.  Number two, we depend heavily on trust, yet trust is not a contracting strategy.  And number three, contractors are almost always more skilled at playing those contracting games than those owners are. WENDY GROUNDS:  Hey, Ed.  Welcome to Manage This.  Thank you so much for joining us today. ED MERROW:  Well, thank you, Wendy.  I’m glad to be here. Meet Ed WENDY GROUNDS:  We are looking forward to getting into this topic.  It’s not something that we’ve talked about before, and I believe you’re quite the expert and the right person that we should be talking to today.  But before we go there, could you tell us a bit about your story, how you got into project management? ED MERROW:  It goes way back.  After I left UCLA, where I was a professor, to go to the RAND Corporation, that’s really when I started my journey in projects.  At RAND, I started the process of trying to understand why new technology projects overran so much, so often.  That research ultimately led me to start Independent Project Analysis back in 1987; and we’ve been going strong ever since, really trying to understand at a first principles level the relationship between what owners, in particular owners, do on the front end of projects and what we get out in terms of project quality at the end.  The contracting work that I’ve done is really very much part and parcel of that whole picture. BILL YATES:  This is going to be a powerful conversation for us to have for our project managers.  This is an area that just scares the pants off project managers, excuse the expression.  But when we get into procurement, and we get into contract types, many project managers just freeze and go, “Okay, this is scary for me.  The more I can understand, the better, the more prepared I think I’ll be.”  So this is a very valuable conversation we’ll have. ED MERROW:  It’s a very complex subject, that goes across economics, understanding markets, understanding competition, a lot of psychological factors associated with contracting.  You know, I always describe project managers as a pretty hard-headed bunch in almost everything except contracting.  When it comes to contracting, we often come to believe things that just plain aren’t true, in part because what we thought we learned about contracting in a particular project really was the wrong lesson.  I wanted to step back and say, look, can we actually put some data around this issue so that we’re better guided as to what works and what doesn’t? Contract Strategies for Major Projects WENDY GROUNDS:  Before we go into this a little further, I just want to talk about your book.  You wrote “Contract Strategies for Major Projects.”  Now, you have done a lot of research focusing on how contracting strategies and delivery systems shape project results, and you’ve shared those findings in this book.  Can you describe the goals and the particular audience for your book? ED MERROW:  Well, my audience is primarily project managers and, to some extent, business sponsors of projects.  Sometimes my audience will be procurement.  Sometimes the audience is the legal side of projects, both on the owner and the contractor side.  One of my hopes in writing the book is not only to shed some empirical light on the subject, but also to try to bring some sense of we need in our contracting relationships to be fair, and we need for the relationships to be self-enforcing, which is to say that the best contract in the world is the one that you sign, put in your lower left-hand drawer, and never see again.  That’s the perfect contract.  But when things don’t go perfectly, I want that contract to help us sort things out, rather than make things more difficult. Hiring Contractors is Never Easy BILL YATES:  One of the things Ed that we wanted to bring to you, just thinking of some of the great quotes you had in your book, hiring contractors is never easy.  And quite frankly, this is an area of great concern for project managers; you know?  It’s like, okay, we have a project that we need to have done.  We’ve got to go outside of our organization and hire some contractors to complete the work.  Or it could be the owner that’s going about that contracting and seeking those people out. This quote really made me laugh in your book.  You said, “The worst contractor ever was the one on the last project, and the best contractor ever will be the one on the next project.”  I like that.  I can relate to that.  You know, I’m an optimist anyway.  So I might look at it and go, “Man that was a terrible experience we had in this last project.  That’ll never happen again.  This is going to be totally different in this next project.” Key Principle #2 ED MERROW:  You see, I always tell owners, and sometimes it upsets them, I say, “Look, contractors do good projects well and bad projects poorly. You’ve got to understand that almost has to be the way it is.”  And I say that because, if a contractor can’t do a well-put-together, well-front-end-loaded, really strong business case project well, he can’t do any project well.  And the market very quickly eliminates those players.  Point of fact, contractors will do good projects well.  And when as owners you set them up to fail, they usually will.  Plain and simple.  And the fact that they’re easy to blame doesn’t really change anything. WENDY GROUNDS:  That was number two of your key principles of contracting.  I just took a look, and I thought, “I’ve heard that before.”  What we want to run through today, we’ve taken these from your book because we thought they were the most applicable to project managers.  So you have the 10 key principles of contracting.  And you warn your reader in Chapter One, you say, “If one pursues a contracting strategy that flouts one or more of these principles, it’s very likely trouble is ahead.”   #1 There is No Free Lunch So we’d like to run through these.  I’m going to start with number one, which you say, “There is no free lunch.”  Can you tell us what that means? ED MERROW:  Sure.  Contracting always involves some version of what’s called the principal-agent problem, which is to say that a contractor will never perfectly do what an owner wants.  It’s simply inevitable, if only because communication is less than perfect.