Fixing loss-making contracts. Asking the right questions to get to the right answers.

F

Many companies are uncomfortable bed-mates with low-margin contracts and, this not being the original plan, want to fix whatever is broken sooner rather than later.

The ‘fixing’ process will be based around answering five key questions – the aim not just to significantly improve profitability, but to avoid a recurrence by creating a platform for organisational learning.

Let’s look at each of these questions in turn.

What factors changed between the final approved bid costing model, and what subsequently unfolded post-award?

The contract will have been bid on information from a variety of sources. The client will have provided information throughout the bid process. Data will have been available internally. Suppliers will have contributed. Assumptions made to fill-in any gaps.

All this information will have been incorporated into the bid costing model and technical proposal. The bid team, not unreasonably, will have expected that the scenario which the bid was prepared on to come to pass. But it hasn’t. Something changed. Probably several things.

But before a comprehensive solution can be created these ‘several things’ need to be identified and there will be several key areas to look at.

First will be looking for differences between each line on the bid costing model and the operational P&L. Where are the differences and whats causing them? What changed between then and now?

Next will be comparing the technical proposal in the bid with the contract and the scope of work performed on-site. Are there differences between any of these? If so, why?

This will create an initial list of issues and from which it will be apparent what are the main causes of the problems. We come back to this later.

Are there client responsibilities defined in the contract not being fulfilled which are increasing operating costs?

Clients often don’t provide resources and services that the contract binds them to. This is likely to reduce your efficiencies and increase your operating costs. Why do contractors accept this? There are lots of reasons.

Inadequate contract control resources and processes. Poor contract handover between the commercial and operations teams. Inadequate contract coordination with the client. Practical inability of the client to provide. An uncooperative client. Differences in contract interpretation.

More issues to add to your list. Again, it will be apparent the extent to which these are impacting your costs and which are the major impact issues.

What were the direct causes, and underlying root causes, of the issues raised in the first two questions?

By this stage the major problems will have been identified. The direct causes will also probably be understood.

Expected revenues that did not materialise may have been caused because estimated quantities used while bidding not materialising. Prices may have had to be reduced because of competitive pressures. Macro-economic or geo-political factors may have reduced expected business volumes.

Operating costs may be higher than planned because incorrect cost data was used in the bid model. Or costs were overlooked. Inadequate coordination during the handover to operations. Operational inefficiencies, poor contract variations control, and weak internal controls.

Differences between the scope of work and specifications in the technical proposal, contract documents and on-site service delivery also often contribute to higher than budgeted operating costs.

There are many reasons for this. Inadequate handover to operations from the bid team. An inattentive Site Manager. Staff untrained in contract requirements. A demanding client and on-site manager inexperienced in handling and escalating contract change requests.

These are the direct causes. But it’s much more important to understand what are the underlying root causes. If these are not identified and addressed the organisation will be trapped in a Groundhog Day.

The same issues cropping up on different projects. Nothing ever improving.

Root cause analysis involves looking at each of the problems and its direct cause(s) and asking what really caused it. Where were the inadequacies which, if changed, would have averted them? Organisation structure? People? Equipment? Facilities? Competencies? Process management?

What corrective actions can be taken to address these issues and improve the profitability of the contract without undermining the client relationship?

The review process will have highlighted issues that have been created internally and so can be resolved internally. The corrective actions for these will have already emerged throughout the contract analysis review process.

Organisational changes may need to be made. New processes may need to be introduced. Internal controls may need to be strengthened. Investment in new facilities and equipment might be required. New technologies may need to be deployed.

It may also have highlighted issues that need the support and cooperation of the client. These come in two varieties. Those things which they are contractually obliged to provide, and those they are not. The first group are normally easier to negotiate than the second.

Engaging with your client on those responsibilities that they are not living up to will doubtless involve a bit of horse-trading to find agreement. Most clients are reasonable and a middle ground will be found. If they do not, you may be thinking about an exit strategy depending on the implications.

By now you will have exhausted all options to improve the profitability of the contract(s) within your control and without needing to renegotiate contract terms with the client. This is always the last resort, if only to demonstrate to the client your due diligence as part of negotiations.

So, you know you are capturing 100% of your revenues. Your operating costs are as low as they can be. You have eliminated scope creep and your client has agreed, hopefully, to meet their obligations. Things are improving, but you are still in a low-margin or loss-making situation.

Now what?

Now you are getting close to the end of the road and you probably need to engage with the client for a price revision. If this is the case you want two things on your side. The contract language and your relationship with them.

If the contract language is against you (e.g. it’s a fixed price multi-year contract with no provisions for price revision or early termination) you might still come out with a good result if you have a great relationship with the client.

If the contract language is against you and you don’t have a great relationship with the client you could be in trouble.

Worst-case scenario? Your client refuses a price revision and you don’t have an early termination exit clause. You are stuck with the contract until it ends, or you walk-away.

The ‘walking-away’ option clearly needs to be taken after careful consideration of the probable consequences.

To mitigate the risks of your organisation ever finding itself in this situation it needs to be absolutely clear in several areas. It needs to know the type of clients it wants to take on (and those it doesn’t), and it needs to know what contract language it will and won’t accept.

Perhaps most importantly, it needs to know how it manages its client retention processes. This ensures that, if worse comes to worst, and you need to have a difficult discussion with them on pricing, they are already on your side.

What organisation-wide lessons were learned that could improve overall profitability and reduce the risk of taking on loss-making or low-margin contracts in the future?

Up to this point we have been discussing how to turnaround one or more contracts which are in a low-margin or loss-making situation. But it’s important to look at the wider organisation to understand how it has to change to avoid this happening again in different regions.

Different processes may need to be enhanced. Estimating and tendering. Contract review and approval. Post-award handover to operations. Scheduled contract compliance audits. Contract variations. Operational cost control. Possibly others.

Employee competencies may also need to be strengthened in each of these areas through vocational education, on-the-job training, or coaching. Maybe even the organisations approach to selection, recruitment and training needs reviewing.

The organisation structure may need to be reviewed. New responsibilities may need to be added into existing roles. New positions may need to be added if the potential cost savings justify it.

New technology solutions may be required.

In days gone by we could simply hire more staff to get new work done. Nowadays it’s not always that easy. Employment costs are rising. Finding people with the right skills more difficult. Retaining them once you have. Internationally, getting employment visas is getting more difficult as governments seek to increase nationalization in the workforce.

Tomorrow’s solutions are less likely to be in saying we need more people. It’s going to be saying we need more technology.

We hope you have enjoyed this article. Please contact us to discuss how we work with clients to fix underperforming contracts and how we put risk control measures in place to avoid them developing in the first place.

Daniel Fox ǀ Daniel.fox@foursimpletruths.com

About the author

Daniel Fox

Daniel Fox is the Director of Four Simple Truths, a team of experienced business coaches focused on assisting leadership teams to transform the financial performance of their organisations to achieve their business and personal goals. Please contact us at enquiries@foursimpletruths.com.

19 comments

By Daniel Fox