Value-Led contracting for agile development projects

Value-Led contracting for agile development projects

Many organisations are focusing more of their IT development efforts on agile based methodologies. The benefits of this are clear in terms of providing the opportunity for businesses to develop products faster and with less risk that the end result doesn’t match expectations. Unfortunately for many however, the reality falls short of the potential as costs and quality spiral out of control in the name of a ‘shippable product’ or story points delivered. Although some of the challenges with agile are inherent in the method, many stem from the way in which the projects are sourced, contracted and governed.


At Leadmark, we have been exploring the governance challenges raised by agile projects. We believe that a fresh approach can ensure that agile development contracts are fit for purpose. Our aim here is to introduce a new approach to contracting for agile development projects that will be an effective basis for agile projects to optimize value and minimize risk and administrative overheads.

We see two primary models being used in the market. Each of which presents the client organization with high degrees of risk in terms of value for money and successful business results.

1. Time and Materials
On the surface a suitable model for agile, since uncertainty on detailed specifications make up front cost and timescale targets impossible. Contracts instead focus on quality metrics (and sometimes quasi output metrics such as story points delivered), agility in terms of remaining flexible and responsive to changing needs, and monitoring time as the cost driver. In this model however, the risks to overall budgets and timescales in achieving desired business objectives is clear and fully borne by the client organization.

2. Fixed price sprint bundles
This model tries to replicate traditional contract models to put some degree of outcome responsibility on the supplier by setting limits on scope and costs over a defined period of time (usually no more than a couple of months or 3-5 sprint cycles). Overheads to define specifications per sprint bundle lead to high administrative loads and ultimately little difference in terms of cost and timescale control from T&M, since there is no contractual agreement on full scope and planning up front. If 3 sprint bundles isn’t enough to realize objectives, more simply get added – even if the negotiations on price with suppliers get tighter and tighter, there remains little real risk sharing on costs for results.

Our Value-Led sourcing for agile method is an alternative that is specifically focused on addressing the underlying causes of risk and dissatisfaction in agile sourcing.

• Poor delivery team focus on business result over sprint features (known as ‘the Feature Factory’)
• Lack of shared incentives to control overall timescales and costs
• Unclear accountabilities between agile process management and contract/commercial management

This paper will take you through the critical aspects of sourcing governance and illustrate the adjustments that need to be made to optimize value and minimize risk and administrative overheads for agile sourcing.


Contract structure and scope

Unlike a traditional contract that aims to document a great deal of detail on requirements, specifications, control metrics and policies/procedures, a Value-Led agile agreement should remain relatively light and simple to manage, since the agile process requires greater agility in contracting as well but the desire is to avoid making a cottage industry of checks, controls and change requests. The best way to create this type of agreement is to split static objectives and dynamic objectives between the Master Agreement and Statements of Work (SoW). In a nutshell, the breakdown in contract structure should be similar to the breakdown in figure 1.

Figure 1.

Looking at Figure 1, you’ll notice the use of Objectives and Key Results (OKRs). This is a critical element to Value-Led sourcing for Agile. Unlike traditional contracts that focus on detailed specifications and/or product features. Value-Led uses the market recognized OKR model (used by Silicon Valley firms like Google and Microsoft to steer business results) to capture the objectives behind a relationship and project and then map key results measures to these as a means to keep delivery team aligned with business priorities and ensure iterative deliveries always contribute, in a measurable way, to business value. It’s important to note that the goal is not to have 100% scores on key results, because this introduces a level of required certainty that is unattainable in agile. An objective is considered met when 80% of key results (either by volume or performance) are met. Additionally, OKRs allow contract and commercial teams to focus on and manage overall sourcing value, without having to get into the operational domain of delivery teams looking at things like stories, burndown rates and velocities. If you want to know more on OKR’s in general you may want to check out this youtube video.

Essentially, an agile contract (SoW) focusing on outcomes can be created once and not amended throughout its lifecycle, irrespective of changes in story priorities or sprint cycle speeds/volumes, as long as the guardrails of objectives (that include business case objectives such as speed to market and budgets), remain valid. To help achieve this objective of simple to manage agreements, Value-Led requires that some effort is put in to identify areas of unpredictability in a project. This helps keep both sides conscious of risks that may derail objectives. If the unpredictability of a project is high, then risk reduction measures should be incorporated into the Key Results that are tracked regularly.

Figure 2.

In terms of the challenges in agile sourcing, the streamlined SoW and OKR based contracts address the issues of delivery team alignment to business objectives and clarity between project and contract/commercial focus, but the question remains: How to incentivize risk sharing between client and supplier? Effective and balanced risk sharing is a known predictor of sourcing success. The answer lies in the implemented underpinning commercial model.


Underpinning commercial model

As explained in the section above, Value-Led sourcing for agile shifts away from frequently used T&M models and reinstates a level of outcome based contracting. The challenge remains however on how to set up a pricing model that incentivizes delivery against business objectives, without mapping pricing directly to successful delivery. For agile projects with no detailed up front specification of success, mapping supplier fees directly to project output presents too great a risk for suppliers. Value-Led sourcing for agile therefore uses a blended commercial model, taking the best practices for open book sourcing and results based sourcing. In the Value-Led commercial model, the client pays an allowable cost for process (the work being done irrespective of results) and the supplier’s margin is then dependent on results. The client agrees to pay, at cost rates, the efforts of the delivery team with margin and management fees specified separately for the agreed target timescale of a project. These fees are at risk based on the supplier’s ability to meet OKRs. The greater the unknowns in a project, the larger the team sizes, the more complex the organization and business systems involved, the greater this fee component will be.

Figure 3.

This model keeps the financial incentives aligned with risk ownership. The client has chosen for an agile approach that puts risk on supply teams of unknown effort. This is covered by ensuring the client pays the costs for effort used. The client however is choosing a sourcing partner based on their expertise and ability to deliver, this is where the management and margin fee put the risk to deliver against these expectations with the supplier. Additionally, both parties are incentivized to make good decisions and steer the sprints towards a meaningful completion of OKRs to prevent overrun on the project in terms of extra sprints due to rework OR extra sprints due to overbuild/poor product ownership. Only where change control is really necessary on the budget guardrails, is a contract change control required.

Although this model has many benefits, it is important to recognize it can only work effectively in organisations that accept the following:

• Overall payments may be higher than regular T&M, where a premium is paid for quality and reduction of risk on result;
• Governance and project teams are willing to be collaborative and transparent. Continuous feedback to keep key results effective is needed.

To manage this model with minimal overhead, OKRs need to be assessed regularly but not necessarily every month or on every sprint. A good starting point is make result based fees payable on a quarterly basis but this frequency must ultimately be appropriate based on the overall timescales and risks of a project. The detailed implementation of this model requires some consideration on measurement methods, anticipated performance bandwidths and resulting payment bandwidths.


Ongoing governance activities and accountabilities

The final step to implementing a Value-Led sourcing model for agile development, is embedding a clear set of governance activities and accountabilities that align to the contracted way of working. This requires that contract and commercial accountabilities are clearly segregated from project/sprint management accountabilities. A simple way to look at this is:

A. The contract/commercial team are responsible for ensuring contracts and financials are effectively used to mitigate sourcing risk, which requires the following:

• SoW’s effectively capture OKR’s agreed by business stakeholders;
• Cost pricing is in line with market standards;
• Margin pricing is negotiated fairly based on risks;
• OKR reviews are tracked to ensure compliance to contract and ability to implement commercial model;
• Payments map to effort and performance;
• Contract changes to keep OKR guardrails relevant happen as needed but are challenged to keep to a minimum;
• Decissions with business stakeholders are managed to ensure fair use of margin payments as levers to steer performance.

B. The project / delivery team are responsible for ensuring work is done compliant to the set out standards, objectives and agile process.

• Review and reporting on OKR’s as part of regular agile ceremonies;
• Tracking and managing operational agile metrics to ensure professionalism and effectiveness of sprints;
• Working with product owners and stakeholders to capture and document sprint cycle requirements;
• Informing / predicting changes to required OKR guardrails.

In practice, this type of governance model requires regular contact between delivery teams and contract/commercial teams but it does not require contract/commercial involvement in the ongoing decisions made by the delivery teams in executing the project. (Note that for smaller organisations and projects, the difference between these areas of focus may simply be in roles, rather than separate people/teams). Contract compliance checks are done in line with the result based fee payment schedule and can easily be combined with a regular supplier governance meeting.

With many organizations continuing to leverage the benefits of iterative ways of working, taking a Value-Led approach to agile sourcing relationships can be an effective way to drive increased performance and value from these arrangements. For more information or detail on how to operationalize the Value-Led structures within your teams, please contact Leadmark for a no obligation chat.