Contract bites: Contracting for ERP Implementation Success
20
November 2014
Mayer Brown Newsletter
Stories of ERP
implementation disasters are numerous and stunning in scale and frequency.
These failures are so common that reading the literature on the subject leads
to the conclusion that successes are in the small minority. In fact, one recent
study estimated that only 6.4% of ERP projects are completed on time and within
budget.1 The reported costs of abandoned
projects can be enormous—$125 million in the case of Avon. But the costs of an
improperly implemented system are equally high. Hershey and Nike each reported
$100 million in lost sales and significant drops in stock price due to problems
in their new ERP systems.2
While many of the risks
in an ERP implementation project are beyond the control of the lawyers
supporting the project, understanding why these projects often fail and what
success looks like will help you guide your business clients to a contract
structure that promotes success.
Why Do ERP Implementation
Projects Fail?
Companies routinely underestimate the complexity and difficulty of ERP implementation projects. Among the most-cited reasons for implementation failures are (1) lack of a clear understanding of what the company wants to achieve, (2) lack of a detailed plan for achieving what the company wants, (3) underestimating the effort required by the company’s management and personnel, (4) unplanned reports, interfaces, forms and enhancements, (5) insufficient testing, (6) insufficient training of company personnel impacted by the project, (7) insufficient work done to overcome the natural resistance to the changes needed to adapt to the new systems, (8) incentives for the implementation provider to expand the project and (9) inadequate project management.
Companies routinely underestimate the complexity and difficulty of ERP implementation projects. Among the most-cited reasons for implementation failures are (1) lack of a clear understanding of what the company wants to achieve, (2) lack of a detailed plan for achieving what the company wants, (3) underestimating the effort required by the company’s management and personnel, (4) unplanned reports, interfaces, forms and enhancements, (5) insufficient testing, (6) insufficient training of company personnel impacted by the project, (7) insufficient work done to overcome the natural resistance to the changes needed to adapt to the new systems, (8) incentives for the implementation provider to expand the project and (9) inadequate project management.
How Can the Legal Process
and Contract Structure Support Success?
The contract can promote success in three important ways. First, the contract can define key project details, including deliverables, milestones and acceptance criteria. Second, the contract can provide the process for how the parties will work together, including making changes and obtaining required approvals. Third, the contract can provide incentives for the service provider to achieve the company’s desired outcome.
The contract can promote success in three important ways. First, the contract can define key project details, including deliverables, milestones and acceptance criteria. Second, the contract can provide the process for how the parties will work together, including making changes and obtaining required approvals. Third, the contract can provide incentives for the service provider to achieve the company’s desired outcome.
What is the Best
Contracting Approach?
DEVELOP A PROJECT PLAN
A solid project plan would set forth a detailed list of activities, staffing, interim and final deliverables and associated milestones. The project plan should be linked to the contract through the use of defined terms and milestone dates from the contract. Each milestone should clearly identify all required completion criteria. Contentious milestone discussions often signal that the parties have not clearly defined and documented the project’s goals and scope.
DEVELOP A PROJECT PLAN
A solid project plan would set forth a detailed list of activities, staffing, interim and final deliverables and associated milestones. The project plan should be linked to the contract through the use of defined terms and milestone dates from the contract. Each milestone should clearly identify all required completion criteria. Contentious milestone discussions often signal that the parties have not clearly defined and documented the project’s goals and scope.
ALLOCATE RESPONSIBILITIES
BETWEEN THE PARTIES
This can be done using a matrix that details project activities and defines which party will be responsible for each activity. “Joint Responsibility” should not be used since that may mean neither party will be in breach if there is a failure. Likewise, assumptions should be removed unless there is a clear outcome if an assumption fails. If there is a constraint that may be exceeded, it is best to have a clear change process and default pricing in case price changes cannot be agreed.
This can be done using a matrix that details project activities and defines which party will be responsible for each activity. “Joint Responsibility” should not be used since that may mean neither party will be in breach if there is a failure. Likewise, assumptions should be removed unless there is a clear outcome if an assumption fails. If there is a constraint that may be exceeded, it is best to have a clear change process and default pricing in case price changes cannot be agreed.
CHOOSE A DEAL STRUCTURE
The best choice of structure depends on the project, and the company’s skills, risks and service provider. Available structures fall into three main categories: “Assist;” “Deliver;” and “Shared Risk.” Each structure has its own unique features.
The best choice of structure depends on the project, and the company’s skills, risks and service provider. Available structures fall into three main categories: “Assist;” “Deliver;” and “Shared Risk.” Each structure has its own unique features.
In the Assist structure,
the service provider works at the company’s direction and is paid on a time and
materials basis. This approach allows the company to start quickly and make
changes at its discretion, but the company bears the entire risk of budget
overruns and schedule delays.
In the Deliver structure,
the service provider commits to work according to a specified schedule for a
fixed fee. This makes the service provider highly motivated to complete the
project quickly and efficiently, but may result in the company having to sign
change orders that increase the fixed fee and extend the schedule if the
contract fails to clearly and completely define desired outcomes. These risks
are heightened by the service provider’s financial incentive to understate
scope and price to win the deal.
The Shared Risk structure is designed to reduce overall risk by aligning incentives and creating a spirit of partnership. It does this by establishing a target budget with shared risks and rewards if the service provider exceeds or stays within budget. For instance, the service provider’s hourly rate may be progressively discounted as it exceeds the target budget and, conversely, increased if it comes in under budget. However, like the Deliver structure, the Shared Risk structure requires an up-front investment in carefully defining desired outcomes. The Shared Risk structure also requires more sophisticated contracting to address changes in scope and direction because of their impact on the target budget and incentives. This requires, among other things, defining clear boundaries between chargeable and non-chargeable changes.
The Shared Risk structure is designed to reduce overall risk by aligning incentives and creating a spirit of partnership. It does this by establishing a target budget with shared risks and rewards if the service provider exceeds or stays within budget. For instance, the service provider’s hourly rate may be progressively discounted as it exceeds the target budget and, conversely, increased if it comes in under budget. However, like the Deliver structure, the Shared Risk structure requires an up-front investment in carefully defining desired outcomes. The Shared Risk structure also requires more sophisticated contracting to address changes in scope and direction because of their impact on the target budget and incentives. This requires, among other things, defining clear boundaries between chargeable and non-chargeable changes.
What is Legal Counsel’s
Role After the Contract is Signed?
Contractual processes and protections are only valuable if understood and properly applied by the parties. Legal counsel supporting an ERP implementation project should train the company’s project team and key stakeholders on the key operational elements of the contract, including the importance of aligning project activities with the responsibility allocations in the contract, and documenting changes using contract processes and documents. Legal counsel should then periodically check in with the project team to make sure the project is staying on track and to address questions that arise from time to time that require legal interpretation and guidance. If disputes arise, legal counsel should assist in promptly resolving those disputes to help foster a productive project environment.
Contractual processes and protections are only valuable if understood and properly applied by the parties. Legal counsel supporting an ERP implementation project should train the company’s project team and key stakeholders on the key operational elements of the contract, including the importance of aligning project activities with the responsibility allocations in the contract, and documenting changes using contract processes and documents. Legal counsel should then periodically check in with the project team to make sure the project is staying on track and to address questions that arise from time to time that require legal interpretation and guidance. If disputes arise, legal counsel should assist in promptly resolving those disputes to help foster a productive project environment.
While the success or
failure of an ERP implementation project lies primarily with the operational,
technical and business teams, a well-crafted, well-managed contract can
dramatically increase the opportunity for success.
Endnotes
1 November 2013 article by Analys Evenstad of Denver IT consultant Panorama Consulting Solutions citing a Standish Group report in CFO.com.
2 “10 Famous ERP Disasters, Dustups and Disappointment,” March 24, 2009 CIO Feature by Thomas Wailgum.
1 November 2013 article by Analys Evenstad of Denver IT consultant Panorama Consulting Solutions citing a Standish Group report in CFO.com.
2 “10 Famous ERP Disasters, Dustups and Disappointment,” March 24, 2009 CIO Feature by Thomas Wailgum.
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