Contracting 101: Risky Business

Well, what’s the problem?
Businesses take risks.

As a retired senior military officer told me more than a few times, this attitude prevailed among his not-yet-retired military colleagues who were responsible for developing RFPs.

Yes, businesses “take” risks. But maybe a better verb would be “calculate” or “estimate” or “cost-in.” Businesses don’t just “take” risks wildly and blindly — not and survive very long, anyway. Based on their experience, they look at what could go wrong and at what could change over the contract term, and they allow some margin for it in their price. They include some contingency for things they can’t control.

So what? So this.

If you’re a client, consider the Work you’re contracting out in light of this train of thought:

  • What uncontrollable risks will the contractor be subject to?
  • What could the downside be for the contractor? What are you likely paying for the contractor to “take” that risk; that is, for every competent bidder to include it in their price?
  • Would it be cheaper to find a mechanism to share the risk?

What sorts of risks are uncontrollable? Input costs are a big one, for everything from insurance to commodities. Market shocks are beyond any contractor’s control: Think of the original oil embargo, or the 9-11 attacks that drove insurance prices, or the hard-to-predict swings in commodity prices that wreak havoc with cost control over the extended schedules inherent in capital acquisitions.

Finding a way to share those risks with contractors will get you a lower contract price. It might also encourage competition, by lowering the bidding risk for smaller companies. Finally, it will prevent windfall earnings if cost increases don’t materialize.

If you’re a contractor, consider suggesting a risk-sharing arrangement if the client doesn’t suggest it. After all, who knows the risks of the Work better than you?