Contract Risks
November 20, 2009
A contract is an agreement between two or more people or organizations to carry out a particular task in exchange of money or something of value. Contracts can be used to mitigate risk such as financial risks, marketing risks, legal risks and confidentiality issues through various means.
Contracts can be used to reduce any performance risks within a project. An organization can use performance guarantees in contracts to ensure that they get the promised levels of service. Contracts should therefore indicate the work to be done by the outsourcing provider also it should indicate the deliverables that the organization expects from the seller and explain in detail what is to be measured, when is it to be measured and how performance is to be measured, basically what, why, who, where, when and how it is to be measured.
Contracts should have confidentiality and privacy clauses that protect the buyer, buyer’s data, strategies and employees. Any business or trade secret that is being used by the organization and is known to many people outside the organization exposes it to loss of business dealings, competitive edge and financial standing. The buyer thus needs to ensure that trade secrets and competitive strategies are kept confidential through clauses in the contract and having confidentiality agreements between the two parties.
Different contract types expose the buyer to different risks. A firm fixed contract can be used by the buyer to reduce risk especially cost overruns in projects. In a firm fixed contract the seller assumes all the risk such as if the project experiences any cost overrun and thus it’s a good contract type for a buyer. (Chen 2006)
Contracts can also be used to reduce legal risk though policies within the contract that protects the buyer. The buyer can be protected from being sued in case of injury, death or loss of property especially in construction projects. The buyer can also be protected from legal risk by having penalties in contracts for late delivery of the project. Late delivery of projects can cause loss of business opportunity, delay in planned cost saving, delay in anticipated product innovations and launches and thus affect the buyer’s profits.
Contracts are also used to mitigate marketing risks especially in agricultural industries where farmers plant crops knowing the established selling price for those crops. After harvesting and due to market price volatility and other factors such as demand, crop quality and crop quantity the price the farmer gets is normally lower than they expected. Contracts are normally used by crop producers wishing to avoid these market risks because the contracts indicate the minimum and maximum price, price adjustments for missing delivery, quality of crops to be delivered etc.
Operational risk in outsourcing is another key issue that the buyer needs to reduce or avoid altogether. These risks occur when the buyer is transitioning into a new relationship with the seller. The buyer needs to communicate effectively with the employees who would be affected by this new relationship either those who will lose their jobs or those who will be reassigned to other departments and other duties.
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