Given the uptick in recent ERP failures, executives are looking for ways to mitigate risk and hold their ERP vendors accountable for the success of their implementations. Organizations are well aware of the challenges and pitfalls of implementation cost overruns, lack of vendor accountability, and troubled implementations, so they are looking for ways to leverage the potential business benefits of their ERP systems without the risk. One mechanism commonly employed is the concept of fixed-cost or fixed-bid contracts as part of the purchase of ERP software.
On paper, it’s a brilliant idea: 100-percent cost predictability and shifting the risk from your own organization to your chosen ERP vendor or system integrator. Hold the vendor’s feet to the fire, guarantee a successful on-time and on-budget implementation, put the responsibility for the success of the project on the people that know the software best and can best influence the outcome, right? It may sound good in theory, but they are more often than not a bad idea in theory.
Here’s a dirty little secret in the ERP industry: fixed-bid contracts have some potentially disastrous consequences that are even more destructive than the problems they were intended to address. In our extensive experience with ERP implementations and serving as expert witnesses for some of the world’s highest profile ERP lawsuits, we found that fixed-bid contracts are often the root cause of enterprise software implementation challenges and failures. It’s not to suggest that they are never a good idea, but it’s never a good idea to enter into a fixed-cost contract without fully understanding the costs and risks.
Here are three consequences of engaging in a fixed-bid contract with your ERP vendor or system integrator:
1. Incentives are misaligned between the ERP vendor and the implementing company. In fixed-bid arrangements, you know exactly what you’re going to pay your system integrator or implementation partner. However, you’re not always getting from the vendor what you need to make the project successful. In fixed-bid engagements, the vendor is financially incentivized to provide a bare-bones implementation scope and provide cheaper and less experienced resources, which may optimize the vendor’s profitability, but is clearly not in the best interest of an inexperienced company about to engage in a risky initiative. Such a relationship with such out-of-sync incentives is not conducive to a successful long-term partnership , as we’ve seen in many of the ERP implementations and ERP failures that we have been asked to consult on.
2. Abdication of responsibility for the success of the ERP implementation. Executives typically don’t understand the complexity and magnitude of a successful ERP implementation, which is why they lean on their selected ERP vendors to help guide them. However, it’s not the implementation partner or even the software itself that is going to make or break the project – it’s the implementing organization itself. Only internal executives and management team members are going to provide the direction, resources, operational decisions, and oversight required to make any ERP implementation successful. However, fixed-bid contracts are more often than not used as a way to abdicate responsibility and expect that the vendor and their software will unilaterally make the project successful. It’s ultimately the way that the non-technical aspects are managed that will determine the success or failure of the project, such as business process design, organizational design, training, employee communications, and project management and oversight. No vendor is going to magically make these issues go away without strong leadership and ownership from the client’s executive team.
3. The fixed-bid buffer can be more costly than managing time and materials. When we advise clients in their ERP selection initiatives and contract negotiations, it is rare to see vendors fix-bid a proposal without including a buffer, often ranging from 30- to 40-percent. In other words, they will take their estimated time and hourly rates and add a buffer to insulate them from the risk of overruns. In addition, as noted in #1 above, they will at the same time reduce their implementation scope, leaving more time- and cost-consuming activities for the client to manage. At the end of the day, this doesn’t reduce cost, it simply shifts costs from the vendor to the implementing client. To add insult to injury, most companies don’t fully understand the magnitude of the costs being shifted from one party to the other, so they end up having extremely unrealistic expectations in addition to increased costs.
This is all not to say, however, that fixed-bid contracts are never a good idea. Rather, it is simply to say that they more often than not result in more unintended consequences than they do benefits. ERP vendors will often use the appeal of fixed-bid proposals to land a deal, and executives typically won’t scoff at the idea, but they rarely deliver the expected benefits and value.
So how can you leverage the potential benefits of fixed-cost contracts without running into the challenges outlined above? First, ensure you have a solid contract review and negotiation process, which Panorama provides to its clients. The fine print and details around scope and responsibilities of each party in the contract can in fact be the silent killers of an ERP implementation, so make sure you have an experienced team helping you through the process. Investing in this process early on can also ensure that you have realistic expectations of what it will take to get your ERP implementation done right, rather than cheaply, quickly, and poorly.
Second, there is no substitute for independent program management and oversight, another service that Panorama provides. This will ensure that you are tightly managing scope, project milestones, budget, and vendor activities in a way that will ensure an on-time and on-budget implementation project.
Finally, don’t forget about the non-technical aspects of your project. This is true of any ERP implementation, but it is especially true for fixed-bid engagements. Make sure you’ve designated enough time and resources for business process definition, organizational change management, conference room pilots, user acceptance, and benefits realization. Odds are your vendor will not include that in their implementation contract scope, but these and other non-technical activities are critical to the success of your project.
Learn more about how Panorama can help your ERP selection, negotiation, implementation and organizational change efforts by visiting our the ERP and IT services section of our website. And remember: our negotiation skills save our clients an average of three to five times the cost of our fees. Don’t sign a contract without us.