Beginning Work Without a Contract in Place

While it’s not something that I would recommend as a standard practice, there will always be times when the work needs to start while the terms get negotiated. There are several issues when you do this.

The first issue I call “point of no return” that I borrow from aviation. In aviation the “point of no return” is when you have consumed enough fuel so that you can no longer return to your place of departure. In contracts the point of no return is when you allow a supplier to proceed so far with the work that your options at that point are limited to only bad ones. You could stop with them, and go back to the beginning and start over with a new supplier. You could still attempt to close the contract.

A second issue is risk. An employee that is performing the work could be injured. The work could be damaged or the work could damage the premises where the work is being performed, etc. Since there is no contract in place, the normal contract protections to manage against the risks also are not in place.

A third issue is the impact the delay would have on the terms you are able to negotiate. With the reduced leverage you have at that point, you probably won’t get you the same terms that you would have achieved if you negotiated it earlier. I’ve had suppliers that I would swear had the strategy to delay coming to agreement as a way to lock the buyer into using them and provide more unfavorable terms in the agreement.

A final issue is while no contract may be in place, since you knew the work was being performed without the contract, you would be prevented or “estopped” from making that claim to avoid paying for the work that the Supplier could claim under the law of equity for “unjust enrichment”.

Since there may be times when you need to start the work without the contract being in place, there are two approaches to managing this. The first is to provide an authorization to start the work with two requirements. The agreement must be completed by a specific date (usually no more than thirty (30) days in the future). The second requirement would be a statement similar to “In commencing the work supplier represents that they have the insurances that are required by buyer’s proposed agreement. An approach such as this eliminated the point of no return issue. The authorization constitutes an offer and the commencement of the work would be an acceptance subject to its terms so in starting the work the supplier is representing that they have the insurances to protect against the risk. If they didn’t you could sue the supplier for damages for breach of their representation. The impact on the negotiation should be minimal as you could start over with another supplier since little time had passed. Your financial exposure would also be limited to only the work performed within that thirty-day period.

Another approach would be to have a simple agreement that says something to the effect that all work performed prior to the execution of the contract will be at each party’s own cost and risk. With that approach the Supplier knows that it’s not in their best interest to delay closing the contract. The more work they perform, the more they are at risk financially. Any claim under equity for unjust enrichment would probably not be successful as they agreed that costs would be at their cost. Any risks are their risks. Lastly, the longer it takes the less leverage they would have in negotiating terms.
In negotiating a clause like this the biggest concern that a Supplier would have is the
buyer could be abusing it and delaying coming to agreement to get more leverage. My response would be that if you have that concern, stop performing the work. There is no contract so there would be no breach if you stop performing. Use that to force the completion of the contract.

I’m sure that there are other alternatives or variations to both of these. All should be structured to drive prompt completion of the contract and the ability of either party to walk away with the least amount of impact and cost if the contract cannot be agreed.

Time to Revenue, Time to Market

Time to revenue describes the length of time from contract execution before the purchase begins to provide revenue or return on investment for the purchase.  On a major contract you could have two proposals where Supplier A offers a price that is less than Supplier B. The hitch is that Supplier A’s proposed time for completion greater than Supplier B’s time.  If time had no value you would most likely select the Supplier A as long as the value both provide are equivalent.  The problem is that time can have a significant value and that needs to be taken into in the decision process.  When there is significant value to that time to revenue it can easily outweigh the difference in the price. It may also have you change your contracting approach, the terms that you use and the risks you may be willing to take to expedite the work.

I learned about time to revenue early in my career. I managed construction contracting for a company and was going to be managing the contracting for a new production plant located in Hong Kong.  The vice president in charge of that production business called and asked me to meet with him to both go over the project and review our plans. The meeting was informative and then he asked me how long everything would take. I provide an estimate based upon our standard process.  His response was simple but firm “too long”.  Then he explained to me that with that production plant in operation he would make enough profit in six months to pay for the entire cost of the building.  The faster we could get it built, the more profit we would make. He was concerned about the time to revenue and the profits that would result from the completion.  Based on that information we got management approval to take as many steps as possible to fast track the project.  In some cases there were cost tradeoffs that had to be made but every time you compared the difference in cost versus the difference in schedule and the impact to time to revenue its was an easy decision.

Time to Market describes the length of time from contract execution before the item purchased can be used or sold in the marketplace on its own or as part of another product or service.  If you ever worked in a product or service development organization you would know that time to market is one of their key objectives.  There are reasons why time to market is important. The first is profitability.  If you are first to market with a product having specific functionality that existing products on the market don’t have, you can charge a higher price.  If you are late coming to market you probably will have to discount your price to take market share.  The second thing that being first to market can do is it can help you lock in customers that use that product or service as part of their product or service.  A classic example of this occurs in the semiconductor business where if you are first to market the customers will lay out their circuit card design to accommodate your specific form factor, mounting approach and other requirements. Once they do that, if another Supplier comes out with a competing product, it probably won’t be plug and play compatible. This means that to use the other Supplier the customer would need to go through the cost and expense of relaying out the circuits and sometimes the card to fit the different product.  Doing that can help you lock in that customer and charge a premium that is not so much that the customer would be willing re-layout the card, but enough so you can charge more than the competition. When there is significant value to that time to market it can easily outweigh a difference in the price. It may also have you change the terms that you use and the risks you may be willing to take to expedite the work.

Sometimes time to revenue and time to market are difficult concepts for procurement to accept. That’s because most procurement groups get measured and rewarded based upon cost reduction so its foreign to them to want to pay more simply to get things performed earlier.  In reality its not a lot different than going to a distributor to purchase a product because they have it and you need it now nor is it much different that paying an additional charge of fee for expedited processing. Any procurement person that wants to build a strong relationship with the business they support should, for any new procurement of any substance, always ask the customer whether there is a Time to Revenue or Time to Market issue with the purchase.  When you do that you are speaking their language.

Differences between production procurement and project based construction procurement

In a recent web post an individual asked whether contracts within project-based sectors such as mining & construction differ from traditional supply chain contracts.  I've worked in both construction and production procurement and they clearly are different. There are different costs and risks involved. In project related contracts there is a start and a clear finish, so there may be less of a focus on on-going relationship management.  Problems you encounter in a project based activity usually impact only the one activity, where as problems that occur in traditional production contracts can affect a huge number of products. While both may have many of the same risks, the frequency and magnitude of the risks will be different.

To briefly explain the differences I’ve created two tables. The first is a comparison based on traditional contract terms.  The second table lists the differences based upon specific issues.

Term of Contract	Supply chain view	Project based view
Changes	All changes require mutual agreement	May contain rights to direct changes to the drawings and specifications
Price	Unit based	Traditionally based upon the completed project
Payment terms	Based on delivery of product	Usually milestone or percentage of completion with retainage held.
Delivery terms	May be agreed by the parties	Has to be the location of the project
Warranties and Representations	Will contain many warranties about the product.	Provides service warranties that work is done in a good work person like manner. Equipment warranties are passed through from suppliers
Limitations on liability	Important, usually concerned with the overall value of the purchases over time	Important. Usually tied to the project value
Insurance	Basic requirement are similar	May require additional insurances such as on completed work or errors and omissions if contractor does any portion of the design
Termination rights	Termination for convenience usually allowed upon payment of certain costs.	Switching suppliers mid-project is difficult and costly. May instead include rights to suspend the work.
Confidentiality	Frequently a competitive concern.	Usually not a concern unless the project involves construction for a sensitive or new process
Breach events	Material breach	Same, although switching supplier is costly so many times will complete work with the Supplier
Dispute management	May include process for management escalation.	Usually will include escalation process
Indemnifications for injury or property damage	Important for injuries caused by defective or unsafe product.	Important because of the nature of the business.
Intellectual Property Indemnifications	Important because of the potential magnitude (could affect huge number of products.	Less important because use is less and getting license for limited use should not be expensive
Governing law	Parties can agree to whatever law they want.	Same, although usually apply the location of the project.
Entire Agreement or Merger provisions	Included as there may have been discussions prior to agreement about the supplier’s product.	Les important as the project will be constructed in accordance with the Buyer’s drawings and specifications
Severability of clauses	Important for interpretation	Same
Time of the essence provisions	Important for managing delivery or breach for failing to deliver on time	Not important as end performance date is the critical date and late delivery is usually tied to liquidated damages rather than termination rights
Order of precedence	Important for conflicts between documents.	Needs to address the precedence between drawings and specifications
Survival provision	Key to identify terms that will survive termination or expiration of the contract	Key to identify the terms that survive the completion of the project.
Waiver Requirements	Need to define what actions constitute a waiver of rights.	Slightly less important as the activity is not-repetitive in nature.
Catch-all provisions for performance of work or services	Usually not included	Frequently included – for example supplier shall provide all plant, labor, equipment and materials to provide ….
Rights to equitable remedies	Included	Included.
Force Majeure	Important	Probably more important was work is subject to more force majeure causes such as weather
Assignment rights	Usually prohibit assignment	Same

Differences on specific issues:

Issue	Supply chain view	Project based view
Acceptance, acceptance criteria	Based upon complying with the product specification.	Based upon complying with the drawings and specifications. May include additional test and acceptance criteria for major systems or subsystems similar to capital equipment
Acceptance or rejection of non-conforming work	Requires return to the supplier.	Requires correction at the product location
Accept Conforming Purchase Orders	May be important term for continuity of supply.	Not important as contract is for the project.
Access To future Products	May be important.	Not important.
Allocation Of Supply	Important activity to address especially if single sourced.	May be cause for supplier requesting a change of design or specification to use alternative.
Amendments	Required to make any changes.	Buyers may use change orders to specify change to the work where the agreement authorizes their use (which is common).
Auto Liability	Really only important is supplier will use vehicles in performance of the work.	Important as project will require substantial deliveries of materials and equipment.
Availability of Spare Parts, Repairs, Support	Important to protect the life cycle cost of the purchase or to provide customer support.	Buyer needs to negotiate that with equipment suppliers for the project.
Bonds	Not commonly used.	Buyers may require performance bonds to pay for added cost to complete the work if the supplier fails or payment bonds to protect against subcontractor liens resulting from supplier non-payment.
Buyer's Responsibility For Instructions	Usually not an issue unless specific instructions are included in the agreement.	More frequently a problem if the Buyer or a Buyer representative such as an architect or engineer instructs the supplier on how to perform the work.
Buyer’s right to make changes To Specifications Cancellation Rights	Requires mutual agreement	Frequently included where there is a pre-agreed formula for compensation of such changes to allow for immediate action.
Carrier selection	Important for any non DDP delivery terms.	Not important. It’s supplier’s responsibility to get to project site.
Claims of infringement	Protection is important as claims can impact production and sales.	Slightly less important. Impact is not the same. Courts would not traditionally require removal and would allow for continue use with license fee.
Claims from Supplier Employees	Traditionally not a large concern as employees work at Supplier site.	Major concern as employees work on customer premises where injuries can be sustained.
Claims for delays, extra costs	Less frequent	More frequent as there may be more interdependence during performance.
Claims For Misappropriation of trade secrets	Important to manage if you will learn technical trade secrets of the Supplier	Less important as work is not being performed in a supplier controlled environment.
Compliance with laws, regulations or ordinances	Can impact the ability to sell or use the product.	Can impact the ability to use the premises
Comprehensive General Liability Insurance	Important for product liability lawsuits	Important for damages or injuries that could be sustained from the work operation.
Conflict Between Documents	Addresses priority between various document including P.O’s	Needs to address priority between drawings and specifications
Continuity Of Supply	Very important, especially if you are single sourced.	Only important to capital equipment that will need parts and service over useful life.
Contract Term	A defined period of time.	Contract has a period for performance, but doesn’t end until all work is complete
Cost reductions	Frequently used for long term relationships.	Seldom required. Focus is more on value engineering to help reduce cost.
Coordination of work	Not important  if supplier performs all work at supplier site.	Important to avoid conflicts with buyer operations, and other suppliers that have access to the site.
Currency	Parties can agree to whatever currency they want (subject to local laws to the contrary).	Usually the site of the project. Main exception would be if major materials and equipment were coming from another country and there was concern about currency fluctuation between the site location currency and the material and equipment source currency
Damages to supplier's property on Buyer's site	Seldom applies unless supplier loans property to the buyer.	Common issue.
Delivery Flexibility	Needed to deal with changes to demand	Only applies to final completion date.
Delivery performance,	Measured for each delivery.	May be measured against milestones and final completion.
Delivery Term	Negotiable	Is the project location
Drawings and Specifications	Frequently are based upon supplier’s standard product specification.	Are unique to the Buyer’s requirements
Early Shipments	Frequently a problem for buyers.	Only problem with early completion is payment may be early.
Epidemic Defects	Major concern to deal with cost that occur in the field and rework to correct problem.	Not an issue as work has to be corrected by the contractor at the project site.
Errors and omissions insurance	Seldom used. Reliance is placed more on indemnifications and insurance to protect against risk	Common requirements for the company that performs the design for the Buyer.
Forecast responsibility	Key issue in supply chain management.	Does not apply to work. May have applied to the design requirements.
How promises are backed up.	Suppliers may want payment assurance and Buyer’s traditionally rely upon damages for non-performance	Buyers may require bonds or other financial guarantees for performance. Supplier may place liens against the premises to protect interests.
Invoicing requirements	Tied to deliveries	Tied to either monthly progress or completion of milestones.
Import, export	Can be major issue for international purchases	Contractors responsibility to manage import. There is no export.
Lead-time	Key issue in managing order issuance.	Non-issue. There is only the dates for completion of the work.
Liens	Seldom apply.	Frequently apply and need to be managed.
Limitation of Actions (aging claims)	Important as agreements can be extend over extended terms.	Less important as project has a final completion date.
Logistics.	Certain logistics such as VMI may be important.	Only address if the buyer makes advance purchases and needs to assign and novate those agreements to the contractor.
Long Term Support	May be required as long as the Buyer has support obligations to their customers.	Contractor traditionally has no obligations and support for capital equipment needs to be negotiated directly with the manufacturer or subcontractor that installed it.
Lot acceptance	May be important to reduce cost of inspection.	Not applicable. Other forms of testing will be specified and done to ensure both quality and compliance with the specifications.
Non-conforming work cost responsibility	Negotiable.	As correction must be performed at the site, supplier bears the cost responsibility
On-time delivery	Important to manage to the production schedule.	Major key dates are final completion or when other contract performance is dependent upon completion b a specific date.
Packing And Packaging	Important to manage against potential damage if delivery term has you assume risk of loss.	Not an issue. Supplier has responsibility to get the material to the site.
Payment terms	Traditionally net terms X days after delivery.	Usually based upon milestones or percentage completion with retainage.
Performance improvement requirements	Important for longer term relationships.	Not important. One of activity.
Personal Injury.	Concern applies only to product liability or automobile caused injuries.	Concern applies to both auto liability, injuries that occur on site and injuries that result from defective performance of the work.
Pricing	Concern is competitiveness of the product over the entire term of the relationship.	Initial price is the price unless there are built in adjust provisions for changes in underlying costs.
Price Changes	May occur at the end of the term before any new term or must be agreed by the parties	Price changes do not occur during the project unless there are provisions to allow for adjustments (such as changes to rates of union contracts).
Property Damage	Concern only with product liability and automobile liability	Concern with automobile liability, liability from operations, and liability resulting from defective work or design
Product Withdrawal - End-of-life	Issue if you don’t have a commitment to a term of availability with Supplier	Not a major concern as you have a one time demand for the item and don’t need it on a recurring basis.
Product Liability	Important concern to protect against.	Not an issue. Issue here is errors or omissions in design or defect in the work that cause injury.
Quality Levels & requirements	Important to manage on-going quality of production.	Not used here. Quality is managed by oversight of work, testing of elements. If correction is needed it will be done on site or a deduct to the price will be taken of agreed.
Remedies for late delivery	May include things like right to cancel order, require premium shipment etc.	Primary remedy used for late delivery here is liquidated damages.
Reschedule Orders	Important tool to manage supply versus demand.	Not a tool used here. May include rights to suspend the work.
Risk of loss or damage in transit	Depends upon agreed delivery point and term	Totally contractor’s responsibility to have items delivered to site.
Subcontractor use, responsibility, approval and changes	Important as part of managing quality.	Same.
Supplier Changes	Depends upon the terms you negotiate.	May allow supplier to make changes to materials and equipment specified to meet the schedule provide that the new materials are equal to the substituted material
Supplier Claims	Usually based upon buyer changes – to volumes, schedule, requirements etc.	Based more on buyer directed changes to the specifications, buyer or buyer subcontractor cause delays or damage to the work. May also include claims for costs based upon differing site conditions where what was represent by topographical maps, soil samples and borings do not accurately represent what’s there.
Taxes and Duties	Dependent upon where title to the product passes.	Duties will be contractor responsibility.  Taxes will be based upon the location of the project
Technical Support needs.	May be required for determining root cause of problems experienced.	Contractor is usually not involve and support comes from manufacturer or subcontractor that installed the item,
Third Party Claims	Major risks are for infringement and personal injurty	Major risk is personal injury
Total life cycle cost	Concerns about life cycle cost involve warranty term and what’s included in the warranty. It also includes the cost of maintenance, spare parts or repairs.	Life cycle cost is driven by the buyer provided specifications and drawings.
Warranty Redemption, RMA processes	Important process to ensure you get committed warranties	All warranty correction must be performed on buyer’s site. There are no buyer returns or return processes.
Workers' Compensation Or Employer's Liability Insurance	Real importance is for situations where the Supplier personnel perform work on the Buyer’s site and could be injured and make a claim against the Buyer.	Very important as most work will be performed on the Buyer’s site