Measuring Legal Exposure Reply

Mind the gapThe function of a contract is to cover legal exposure.  It does not, by and large, govern the relations between parties.  Those are already established by the community and contracts merely document well established facts.  The way the parties will behave will already be a an established reflection of their education, training and previous business experience.  It is naïve to think, for instance, that a contract will be used by engineers to help manage the construction of a building.  On the contrary, the contract will present a myriad of hurdles, obstacles, impasse and problems as the workers try to get on and do their job – build.  It is a truism to say then that almost all litigation is a function of poor contract management rather than poor contract design.  Indeed, I have never met a client who had either fully read OR fully understood the contracts they were in.

A contract, rather, seeks to cover the inevitable areas of risk when two parties necessarily compromise to enter into an agreement. as my father used to say, ‘there are two parties to a contract – the screwor and the screwee.  One party is always disadvantaged.  The lesser party needs to cover their legal exposure and the greater party needs to ensure that not so much risk flows down that the lesser party is overloaded with risk, making the contract unworkable. Picture1Legal exposure is derived from financial risk.  Contracts will generally cover most financial exposure.  However, in Westminster-based systems much of the law of contract is still based in Equity.  Usually, there is still some degree of exposure that remains.  A party can only be forced to  indemnify so much; can only warrant so much and not beyond the reality of the arrangement.legal exposure

Most contracts, however, do not measure the legal exposure a party faces.  Most contracts stick with the standard blanket coverage formula, i.e. zero exposure.  This approach is unhelpful and in many cases counter-productive, because namely:

  • Phantom Exposure.  contract negotiations become unnecessarily bogged down over non-existent risk.  Arguing for 100% coverage when the risk is well covered already is just chasing phantom risk.
  • Lazy.  Quite frankly, the body of knowledge which exists in each sector, the sophistication of clients and the modern quantitative tools which exist to make contracting easier give no excuse for legal laziness.

Measuring legal exposure is both qualitative and quantitative.  Firstly, deriving financial risk is a mathematical function.  Secondly, as exposure is derived from the limitations of contractual coverage then legal exposure is a function of qualitative assessments.

My own method uses a threefold approach, namely:

  1. sensitivity analysis to measure financial risk, and then
  2. three separate qualitative measurements to define whether an element is a legal risk, then
  3. a legal assessment to determine if the remaining elements are covered (i.e. measure the exposure) and to what degree.

All of this is done as a collaborative process around a single bubble chart (shown below).  As is shown in the chart,

  • the bubble size (Z ‘axis’) relates directly to the mathematical analysis of financial sensitivity.
  • the X-axis is a qualitative scoring designed to assess the relative complexity of each item of volatility.
  • the Y-Axis is another qualitative scoring to determine just how close the item is to the project team, i.e. can they actually do something about it?  The less a team can influence a risk the more such risk needs to be pushed upwards so that the corporate functions of a business (Legal, Finance) can act upon it with centralised authority,
  • the colouring, lastly, deals with the notion of immediacy, i.e. prioritisation.

In this way, if a risk is both very complex and not able to be influenced by the project team (i.e. cannot be mitigated) then it, most likely, needs to be dealt with by the Legal function as there will be no way to otherwise influence it when the risk is realised.

Risk-Based Bubble Chart to engender cross-functional collaboration

Once legal risk is conceptually isolated in the upper-right quadrant of the bubble chart then lawyers may make a qualitative determination as to the amount of legal exposure.  For instance, a builder may warrant the quality of workmanship on a specific structure and cover it with insurance.  Legal may determine that there is virtually no statistical evidence that such risk is likely to be realised.  Therefore, the existing premiums easily cover the risk highlighted in the chart.

Alternately, the chart may have defined financial risk beyond, say, the indemnities provided by a firm’s subcontractors.  In such a case insurance or contractual renegotiation may be necessary.  It is important to know that in such circumstances it is precisely targeted cross-functional management energy that is being expended to determine, define and collaboratively deal with specific  financial risks.  Indeed, there is little more any business could hope for.

Hidden Costs in ICT Outsourcing Contracts Reply

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Why are IT outsourcing contracts almost always delivered over-budget and over-schedule?  Why do IT outsourcing contracts almost always fail to achieve their planned value? How come IT contracts seem to be afflicted with this curse more than any other area?

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The common answer is that (i) the requirements change,  and (ii) that handovers from the pre-contractual phase to in-service management are always done poorly.  These are both true although hardly explain the complexity of the situation.  If requirements change were an issue then freezing requirements would solve it – it doesn’t.  The complexity of large ICT projects is derived directly from the fact that not all the requirements are even knowable from the outset.  This high level of unknown-unknowns, coupled with the inherent interdependence of business and system requirements, means that requirements creep is not only likely but inevitable.  Secondly, (ii) handover issues should be able to be solved by unpicking the architecture and going back to the issue points.  This too is never so simple.  My own research has shown that the problem is not in the handover but that the subtleties and complexities of the project architecture is not usually pulled through into the management and delivery structures.  Simply put, it is one thing to design an elegant IT architecture.  It is another thing entirely to design it to be managed well over a number of years.  Such management requires a range of new elements and concepts that never exist in architectural design.

The primary factor contributing to excessive cost (including from schedule overrun) is poor financial modelling.  Simply put, the hidden costs were never uncovered in the first place.  Most cost models are developed by finance teams and uncover the hard costs of the project.  There are, overall however, a total of 3 cost areas which must be addressed in order to determine the true cost of it outsourcing. 

True Cost of IT

1.  Hard costs.  This is the easy stuff to count; the tangibles.  These are the standard costs, the costs of licensing, hardware, software etc.  It is not just the obvious but also includes change management (communications and training).  The Purchasor of the services should be very careful to build the most comprehensive cost model based on a detailed breakdown of the project structure, ensuring that all the relevant teams input costing details as appropriate.

2.  Soft Costs.  The construction industry, for instance, has been building things for over 10,000 years.  With this level of maturity one would imagine that soft costs would be well understood.  They are not.  With project costs in an extremely mature sector often spiralling out of proportion it is easy to see that this might also afflict the technology sector which is wildly different almost from year to year. 

Soft costs deal with the stuff that is difficult to cost; the intangibles:  The cost of information as well as process and transaction costs.  These costs are largely determined by the ratio of revenue (or budget in terms of government departments) against the Sales, General & Administration costs, i.e. the value of the use of information towards the business.  Note that this information is not already counted in the cost-of-goods-sold for specific transactions.

Soft costs go to the very heart of how a business/government department manages its information.  Are processes performed by workers on high pay-bands?  Are workflows long and convoluted?  The answers to these questions have an exponential effect on the cost of doing business in an information-centric organisation.  Indeed, even though the cost of computing hardware is decreasing, the real cost of information work – labour – is increasing.  This is not just a function of indexed costs but also the advent of increasing accreditation and institutionalisation in the knowledge worker community.  Firstly, there is greater tertiary education for knowledge work which has hitherto been unaccounted for or part of an external function.  The rise of the Business Analyst, the Enterprise Architect (and a plethora of other “architects”) all serve to drive delivery costs much higher.  Not only are the costs of this labour increasing but the labour is now institutionalised, i.e. its place and value is not questioned – despite the data showing there seems to be limited economic value added through these services (i.e. no great improvement in industry delivery costs).

3.  Project Costs.  Projects are never delivered according to plan.  Requirements are interpreted differently, the cohesion of the stakeholder team can adversely impact the management of the project, even the sheer size and complexity of the project can baffle and bewilder the most competent of teams.  Supply chain visibility, complicated security implementations and difficult management structures all add to project friction and management drag.  There are many more factors which may have an adverse or favourable effect on the cost of performing projects. 

IT Transition Cost Graph

In the Defence community, Ph.D student Ricardo Valerdi created a cost model – COSYSMO – which isolated 14 separate factors peculiar to systems engineering projects  and gave these factors cost coefficients in a cost model.  Ultimately, each factor may be scored and the scoring then determines the effort multiplier, usually a number between approximately 0.6 and 1.8.  Naturally, when all factors are taken into account the overall effect on the contract price is significant. 

More importantly, for IT implementations, the “project” is not short.  IT outsourcing projects are generally split into 2 phases:  Transition and Transformation.  Transition involves what outsourcers call “shift-and-lift” or the removal of the data centres from the customer site and rear-basing or disposal of the hardware which allows the company to realise significant cost savings on office space. 

During the second phase – Transformation – the business seeks to realise the financial benefits of outsourcing.  Here, a myriad of small projects are set about in order to change the way a business operates and thereby realise the cost benefits of computer-based work, i.e. faster processes from a reduced headcount and better processes which are performed by workers on a lower pay-band. 

IT outsourcing  is not just about the boxes and wires.  It involves all the systems, hard and soft, the people, processes and data which enable the business to derive value from its information.  Just finding all of these moving parts is a difficult task let alone throwing the whole bag of machinery over the fence to an outsourcing provider.   To continue the metaphor, if the linkages between the Purchasor and the Vendor are not maintained then the business will not work.  More importantly, certain elements will need to be rebuilt on the Purchasor’s side of this metaphorical fence, thus only serving to increase costs overall.  The financial modelling which takes into account all of these people, processes and systems must, therefore, be exceptional if an outsourcing deal is to survive.

Qld Govt On Track to lose Billions Through Poor Outsourcing Reply

In a recent article in online technology ezine Delimiter – “Qld Health Preps Huge IT Outsourcing Deals” – Renai LeMay points out that the Qld government will need to spend an unadjusted $7.4 billion over the next 5 years in order to replace and upgrade 90% of its outdated ICT portfolio.

The question is whether it has learnt from the Qld Health outsourcing debacle with IBM and will it move forward with its best foot?  It is unlikely, given that HSIA seems thrust into the contracting process too early with too little.  With the pace seemed to be set by the Costello audit, the HSIA is now engaging in early vendor ‘discussions’ (IBM notably excluded) without even a detailed set of business requirements, system parameters and financial boundaries.

In letting vendors shape the early development of these outsourcing contracts the government is on track to lose billions.  This will happen for 3 primary reasons:

  1. Service Management will be overlooked – The failure of virtually all contracts is not in the structure but the management.  Although most experienced litigators have gasped at contracts (usually government) which seemed to have been designed to fail (largely due to something bordering on corruption or undue influence), most are not so designed.  Outsourcing contracts, more than any other, require detailed attention to the management of the service.  Ultimately, the difficulty lies in the paradigm shift from network support to service management.  In other words, the personnel in charge of servicing are now in charge of service management.  In most cases, these jobs are made redundant as the vendor takes them over (unlike TUPE laws in the UK).  Consequently, the knowledge is lost.  Purchasors can protect themselves against service decline by making the vendor buy key personnel.  Better yet, Purchasors should transition these key roles from performing the work to managing the service/contract.
  2. Deals will be too long – Vendors will push longer outsourcing contract lifecycles.  Although, prima facie, there is  nothing long with a long contract it is imperative that such contracts are designed to be managed, i.e. the focus is on the delivery and management Schedules and not the boilerplate of the Operational clauses.
  3. Tech bundles will lack modularity – Qld government loves to re-organise.  After each government their is always a paradigm shift in the Machinery of Government (MOG).  Departments shift and with them so do budgets and internal processes.  These are generally managed within departmental parameters with necessary roles and functions often going unfunded and unfilled for entire cycles of  government.  To reinforce Renai LeMay’s point, it goes without saying, therefore, that the government needs to develop a modular, multi-bundle architecture wherein departments can buy and sell service credits between themselves without limiting the overall strategic cost savings.

In summ, there are numerous ways in which Qld government can guard against the inevitability of cost overruns and poor, overly simplistic outsourcing contracts.  On the other hand, the vendor which offers these first will have a significant advantage.  in many cases, the difficulty will be in convincing QGCPO that novel and innovative contracting vehicles are there for the benefit of the Purchasor and not just vendor voodoo.