Assume that you are the project manager for the construction of a floating platform in the Norwegian sector of the North Sea. A concept has been chosen for oil production from a difficult reservoir with very high pressure, high temperature and a depth to the bottom of about 300 meters. A major challenge is that the production technology to handle such a complex and difficult reservoir does not exist but must be developed.
The work on the development and construction of the platform has been outsourced to a main contractor. This company has further entered into contracts with several subcontractors. Among other things, it has been chosen to build large parts of the platform at a low-cost shipyard in Korea. The installation and completion of the platform will take place in Norway. For the operator, it is extremely important that the project is completed in the summer of 2017. If the project is delayed and the autumn storm comes, the platform cannot be installed in the North Sea until next summer, and large amounts of money will be lost.
Discuss whether you, as the project manager for the operator (the client), should choose: A contract that has a fixed end date for the project with large penalties for delay or a contract with incentives that encourages large bonuses if the project is completed before the agreed end date.
As the project manager for the operator (the client) in this scenario, you should carefully consider what type of contract is most suitable to achieve the goal of completing the project by the summer of 2017 and avoid losing large amounts of money. The choice between a contract with a fixed end date and penalties for delay, or a contract with incentives and bonuses for early completion, depends on several factors. Here are some considerations for both options:
Contract with a fixed end date and penalties for delay: A contract with a fixed end date and subsequent daily penalties may be suitable when you want to place greater responsibility on the contractor to complete the project on time.
The benefits of this approach include:
- Motivation: The potential for penalties can serve as a strong motivator for the contractor to ensure efficient project management and maintain momentum throughout the project lifecycle.
- Project Prioritization: Contractors may prioritize projects with fixed end dates and penalties over other work that has more flexible deadlines to avoid incurring penalties.
- Clear timeframes: A fixed end date provides clear and predictable parameters for the project, and all parties involved have a common goal of meeting this deadline.
- Accountability: By having daily penalties in the contract, the contractor is pressured to maintain progress and ensure that any delays are minimized.
- Financial incentive: The daily penalties serve as a financial motivation for the contractor to complete the project within the agreed deadline.
Disadvantages of this approach may include:
- Conflict and Delays: If the contractor encounters unforeseen problems or technical challenges that cause delays, it could lead to conflicts between the operator and the contractor. This can potentially further delay the project as issues are resolved.
- Compromised Quality: The pressure to meet deadlines and avoid penalties can lead to rushed work, which can negatively impact the quality of the finished product.
- Lack of Flexibility: Such contracts may not allow for much flexibility if unforeseen challenges or changes arise during the project. In such cases, contractors may feel compelled to take risks or make compromises in order to meet the fixed end date.
- Potential for Disputes: If delays occur, determining who is at fault can lead to disputes. Resolving these disputes can consume time and resources.
- Strained Relationships: The use of penalties can strain the relationship between the contractor and the client, which could potentially impact future collaborations.
- Cost Overruns: In a rush to meet the deadline, the contractor may end up underestimating costs or overrunning the budget, which could either reduce their profit margin or lead to additional charges for the client.
Contract with incentives and bonuses for early completion: A contract that offers incentives and bonuses for early completion may be suitable when you want to encourage the contractor to work quickly and efficiently. The benefits of this approach include:
- Motivation: Large bonuses can act as a strong motivation for the contractor to complete the project earlier than agreed. This can increase the likelihood of the project being completed before the autumn storm.
- Quality: By offering bonuses for early completion, the contractor might be more focused on maintaining high quality in the work, while working efficiently to achieve the bonus.
- Collaboration: An incentive-based system can help create a positive collaboration culture between the operator and the contractor, where both parties are interested in working together to achieve early completion.
Potential disadvantages to this approach may include:
- Potential Additional Cost: Offering bonuses for early completion can add significant costs to the project. It’s crucial to weigh whether the potential benefits of early completion justify the additional expenses.
- Uncertainty: While bonuses can act as motivation, they do not guarantee that the contractor will finish the project earlier than agreed. This could lead to disappointment or even conflict if the bonuses were a major part of the contract agreement and are not realized.
- Resource Strain: In their efforts to finish the project early and secure the bonus, contractors might need to deploy extra resources, which can strain their operations or impact other projects they are handling.
- Compromised Quality: The pressure to finish early to earn a bonus may lead some contractors to rush the job, potentially compromising the quality of the work and resulting in longer-term issues.
- Risk Taking: The lure of a bonus might incentivize contractors to take unnecessary risks, such as cutting corners on safety measures, to meet the early completion date. This could lead to accidents, legal issues and other undesirable outcomes.
- Neglect of other important factors: The focus on early completion may cause other important aspects, such as sustainability considerations, to be overlooked.
Conclusion: The choice between a contract with a fixed end date and daily penalties for delay or a contract with incentives and bonuses for early completion depends on the risk tolerance, budget, complexity of the project and the perceived willingness to cooperate between the operator and the contractor. A combination of both approaches can also be considered, where the contract has a fixed end date with moderate daily penalties, while incentives and bonuses are offered for early completion. It’s important to carefully consider the different factors and potential consequences before making a decision that best suits the project’s needs and goals.
This case is taken from the book “Prosjektledelse – fra initiering til gevinstrealisering” – 2016, 4. Edition, by Jan Terje Karlsen.
