CASE STUDY 1

An Automotive Manufacturer Contracts a New Technology

R
ecently, a major US automotive manufacturer was preparing to negotiate
a long-term contract with a key electronics supplier. The supplier had
developed a new technology that would enable customers to access
the World Wide Web from their vehicle through voice activation capabilities.
This technology was considered ‘cutting edge’ and would result in a major
competitive advantage for the automotive company. Talks between the two
companies had been underway for several months, but had reached an impasse.
For one thing, the electronics manufacturer held the only patent for the
technology. This had made discussions difficult. The negotiations had reached
a breaking point when the supplier sent a team of lawyers rather than sending
in a team of sales personnel and engineers to discuss the contract.

The lawyers promptly began making specific demands regarding exclusivity

clauses, nondisclosure agreements, and technology ownership in language that
the automotive technology team did not fully understand. Rather than continue,
the automotive team promptly stood up and left the room. Upon hearing this,
the director of purchasing at the automotive company called up the vice
president of technology at the electronics supplier and demanded that a team
of engineers and sales people represent that company’s interest during the
negotiations. Sending lawyers in was not only adversarial but would likely end
the deal altogether if it continued. The vice president apologized for this situation
and claimed he was unaware that lawyers had been sent in to represent the
company.

At the next meeting a group of engineers arrived from the supplier to discuss
implementing the technology in future new-model vehicle platforms. The
negotiation was successful and resulted in a very interesting contract. The
contract stipulated that the automotive produce would have sole use of the
electronic technology through an exclusivity clause. Further, the contract

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contained wording describing the joint ownership of the intellectual property
contained in the technology. The final point in the contract also stated that the
electronics supplier was required to continue to update this technology into
the future. If the supplier failed to do so and a competing electronics company
developed a similar technology that had superior performance, it was required
to license this technology from the competitor and sell it to the automotive
company at he previously negotiated price. Upon looking at this situation, one
wonders if perhaps the lawyers should have been present at the meeting after
all.

Source: Interviews by Robert Handfield with anonymous executives.

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 CASE STUDY 2
Audit Blasts Oversights in Military Contracts

A
n internal audit of $6.7 billion in military contracts for professional,
administrative and management services uncovered what it called
inadequate government oversight in 105 contracts examined. The
Pentagon spent $51.8 billion last year on all kinds of services contracts — from
trash collection to engineering studies — up from $39.9 billion in 1992. While
spending is rising, the amount of oversight isn’t, the Pentagon’s inspector general
said in a report. In 81 of the 105 contracts reviewed, “contracting officers either
failed to prepare cost estimates or developed estimates that were inadequate
or lacked detail,” the report said. “Deficiencies in estimating clearly left the
government vulnerable —and sometimes at the mercy of the contractor to
define the cost.” In addition, “Contracting officers essentially used contractor-
prepared status reports as evidence of surveillance to determine how well the
contractor was performing.” A major problem, according to the audit, is the
frequent use in services contracts of “cost-plus” deals, in which the government
reimburses all the contractors’ costs and then pays an award fee on top of that.
Typically, cost-plus deals are used on technically challenging, new programs,
where the government assumes most of the financial risk. In “fixed-price”
contracts, which the government usually prefers, the contractor gets paid a set
amount negotiated beforehand. These generally are used when a program’s
cost history and technology are well known. The inspector general found that
the armed forces frequently buy support services from the same company for
years using cost-plus contracts. Instead of making the company stick to a fixed
price, the military covers all the costs as if it were buying a cutting-edge fighter
plane. In one instance, the Army in 1997 awarded Raytheon Corp. a $36.2
million contract for engineering services for the Hawk air-defense system without
any competition. Though this system was first fielded in 1958, the Army still
chose to cover the contractors’ costs, even after 39 years of history with the
same contractor.
Source: Adapted from Associated Press, March 14, 2000.

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 CASE STUDY 3
The Turnkey Trap

T
hose who realise that they do not have the expertise to manage a project
themselves often decide to use the turnkey approach for efficient
execution of a project. The owner in this arrangement expects the turnkey
contractor to take care of all the troubles of project execution and hand over
the key to the owner when the plant is ready for operation. Some believe this
to be the surest way to complete the project not only in the shortest possible
time but also at least cost.

XYZ Company Ltd. wanted to diversity into a new product line. Since they did
not have the necessary knowhow, and also wanted to put the product in the
market at the earliest, they decided to go for a turnkey contract. They were
aware that going turnkey may cost them more but they were hopeful that the
revenue from early production would outweigh the additional cost.

Since the XYZ Company did not have the knowhow, they appointed a technical
consultant to prepare the bid package, evaluate the bids and make
recommendation. Though the company was keen to float the enquiry
immediately, it would not be done as the consultant took several months to
prepare the bid package. The company was not prepared for this and wanted
to make up the delay by setting a still tighter completion target for the turnkey
contractors.

The bidders did not agree to submit their bids by the due date and the date
had to be extended. When the bids were finally received the owner was
disappointed to find that no one had agreed to deliver the plant by the target
set by him. Also the prices quoted by the bidders were much higher than his
estimate. The owner had to engage himself in prolonged discussions for
reduction of price and improvement in schedule.

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Since all the bidders were manufacturers of the main plant equipment, they
were not keen to take up civil and electrical work. The owner agreed to take
out this part of the work from the bidders scope as it was explained to him that
this would bring down the cost of the project. The bidders also suggested that
the owner should procure the proprietary items on which they are adding their
‘mark ups’. But the owner did not agree as it would dilute the turnkey
responsibility and also increase coordination and hence disturb the project
schedule. As there was recession in the industry, the bidders were keen to win
this contract and, therefore, accepted the owner’s stipulation that for the items
not manufactured by them they should work as the owner’s agents and received
a fee for their services. The owner would reimburse the successful bidder for
the cost of these items

The owner did not stop at this stage. He started negotiations simultaneously
with all the bidders in order to get a heavy discount on the price of the main
plant and machinery and also a crash schedule. Finally, he could make one
bidder agree to his crash schedule but on condition that there would be no
delay in the release of payments. The bidder also insisted on a 25% advance
along with the letter of intent (LOI) and an unconditional letter of credit (L/C)
for the entire contract amount after six months of issue of the LOI.

The owner agreed to pay the advance in a phased manner. It was agreed that
release of advances will be linked to a programme of supply of load data and
general arrangement drawings by the vendor. This, the owner thought, would
ensure him to make the civil work ready in time for erection of the plant and
machinery. The owner also made the contractor agree to a penalty/bonus clause
in order to ensure that the contractor makes all out efforts to complete the
project on a crash schedule and meet guaranteed performance.

The project started slipping almost from the first day. Except for the first lot of
load data and drawings, the contractor could not stick to his drawing release
schedule as he was not able to place orders for bought outs as per plan. He
could not even start manufacture of main plant and machinery in his shop
immediately due to delay in supply of manufacturing drawings, non-availability
of materials and existing shop-load.

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It soon became clear that the rate of progress demanded by the contract was
not achievable. The contractor, however, attributed the delay to uncertainty
perceived at his end about the project due to the owner’s not finalising the
agreement. The signing of the agreement was delayed from the owner’s end
by almost three months but the contractor assured the owner that he would
make up the delay in the subsequent months.

The following months brought tremendous pressure on the contractor for the
supply of load data and general arrangement (GA) drawings. The owner had
already lined up a civil contractor and was unable to feed the civil contractor
the structural drawings according to the agreed time schedule. However,
submission of load data and GA drawings to the owner were getting more and
more delayed. It was observed that the contractor did not pass on any advance
to his sub-vendors in a like manner as was done by the owner. Accordingly,
sub-vendor data were getting delayed. However, at the owner’s insistence, a
team was sent to the various sub-vendors’ offices and the team collected
considerable amount of data across the table.

It soon became clear that the first shipment of equipment from the contract’s
own shop is not likely to take place as scheduled unless vigorously expedited
by the owner. Regular review meetings were held with the contractor’s shop
personnel and while manufacturing progress improved, it became clear that
the slippage which had already occurred could not be recovered. After several
months had passed, the owner decided to take up the matter with the
contractor’s top management so that the contract received out-of-order priority.

Interestingly, the contractor’s top management started defending the slippage

on the grounds of delayed signing of contract and non-opening of letter of
credit. The owner explained that the financial institutions would not permit
him to lock-up his money by opening a letter of credit since no material was
ready for despatch. The contractor, however, was insistent that the letter of
credit must be opened immediately as per the contract to enable him to step
up progress. He also made a claim that substantial plant and machinery was
ready but could not be despatched due to lack of a letter of credit.

The turnkey contractor meanwhile lined up a new group of professionals as

their erection sub-contractor with the idea that a new group would be

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cooperative and put in their best effort. This was, however, not acceptable to
the owner. Since considerable slippage had already taken place, it was
considered essential to have a contractor with an excellent track record so that
a part of the slippage could be recovered during erection. The erection contract
was, therefore, terminated and a new contractor approved by the owner was
engaged.

The owner opened a letter of credit for the despatch of items declared ready by
the turnkey contractor. Considerable time was spent in settling the terms. Soon
the owner discovered that what the contractor claimed as ready and despatched
were not erectable. The contractor despatched whatever was ready, whereas
the owner insisted what the turnkey contractor must send items in erectable
sequence. The contractor, however, maintained that this was not possible but
promised to ensure erectable deliveries as far as practicable.

Since materials were not arriving at site as planned, the erection contractor did
not mobilise as promised. Materials which had reached the site lay idle either
because they were not erectable or erection labour was not available. The
situation was intolerable as far as the owner was concerned but he was not in
a position either to rectify the situation or cancel the contract.

The turnkey contractor, on the other hand, suggested that the owner should
directly take charge of erection as the situation at the site was a creation of the
erection contractor who had been appointed on the owner’s recommendation.
The turnkey contractor also expressed his inability to despatch equipment in
an erectable sequence as he was unable to pick-up all the ready materials from
the various sub-vendors with the limited funds that the owner had allowed
him. He threatened that unless a letter of credit for the entire balance amount
was opened immediately he would stop all despatches.

But the owner was not convinced that he should open the balance letter of
credit when all the items were not ready for despatch. He felt that if the letter
of credit was opened for the entire balance amount, the contractor would take
it easy and his project would get further delayed. He was convinced that he
had not so far received a fair deal from the contractor and, therefore, there was
no reason for his to oblige the contractor. The contractor, on the other hand,
concluded that the owner was short of fund and, therefore, there was no point
in expediting the project.

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 CASE STUDY 4
The Case of the Shaky Foundation

C
rews at a construction site for a new supermarket were preparing the
foundation. The excavation had been completed. Now the forms crew
was busy installing the wood and metal framework into which the
cement crew would pour the fresh concrete from the mixer. Duncan, the pouring
supervisor, was watching the placement of the forms. “Be sure that inside form
is properly secured,” he told one of the crew. “That outside from isn’t level yet,”
he advised Wendy Brown, another member of the forms crew. “Last time your
sloppy forms made us look bad.” The crew and Wendy just kept on about their
work without paying too much attention to the instructions handed down by
Duncan. After a while, Duncan left the site to round up his own crew for pouring,
which would begin that afternoon.

Nick Motta, the forms supervisor, who had been at the site office verifying the
blueprints, returned to his crew shortly after Duncan had left. He jumped into
the foundation pit to show the crew how to make the final alignment of the
forms. Wendy Brown, however, told him that the forms had already been levelled
and locked up. “They aren’t in the right position,” said Motta. “Why didn’t you
wait until I got back before bolting them into place?”

“Duncan was here and showed us what to do,” replied Brown.

“Well, he was wrong. And it is none of his business, anyway,” said Motta. “I take
charge of the forms. All he and his crew do is to dump the concrete into them
after we’ve done the precision work.”

At that point the concrete truck rolled up to the excavation. “Get out of the pit!”
shouted Duncan, who was now on the site with his crew. “We’re ready to pour.”

“You’ll have to wait,” said Motta. “Your meddling has held up the job. We are
going to have to realign the forms according to these prints.”

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“That was what I was trying to tell your crew,” said Duncan. “If they had listened
to what I told them, we could go ahead.”

“Talk to me the next time,” said Motta. “But meanwhile, take you and your crew
of apes and get out of here.”

“You get out,” said Duncan. “Or you’ll all get a cement overcoat.” With that, he
opened the chute door on the mixer just enough to let a couple of buckets of
wet cement splash into the pit and on Brown and Motta.

Brown jumped out of the pit and pushed Duncan against the mixing truck.
Duncan shoved back and in a minute there was a free-for-all as the two crews
– forms and pouring – pushed and shoved and swung fists.

Finally someone called the site boss to the scene. The fighting stopped. “What’s
this all about?” he asked.

“Duncan and his pouring crew put their noses into our job once too often,”
said Motta. “And he dumped a load of cement on us.”

“That’s a laugh,” said Duncan. “If I wasn’t here to check up on what they were
doing, we would have one more shaky foundation. And we’d get the blame. I
was just making sure that the forms were right before we poured.”

1. If you were the site boss, what approach would you use to resolve this
dispute? Which supervisor would you sympathize with?

2. What did Duncan do to bring on this conflict?

3. What might Motta have done to avoid the conflict?

4. How might the site boss make sure that similar disputes do not arise in the
future?

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 CASE STUDY 5

C
olossal Country Hospital was coming apart at the seams. With dozens
of newly hired doctors, nurses, and technicians, millions of dollars of
equipment on the road, and patient appointments backed up for
months, the new facility was impossible to use. For one thing, construction
wasn’t finished, and much of what was complete was faulty. Worse yet, the
contractor had placed liens on the property for nonpayment, preventing
occupancy. Costs had greatly outdistanced available financing. The hospital
staff was frantic; the bank was apoplectic; the board of trustees was in despair.

How had it happened? The chairman of the board—head of the local branch of
a financial services company—was baffled. He tried to trace the history of the
project.

Two years earlier, the board members had voted to build an important new
facility and renovate an adjoining older one. They hired the best available hospital
architect. One group of trustees went on to focus its attention on a special
bond issue to provide low-cost financing, while another group put together
and executed a detailed marketing strategy to position the hospital as a world
leader in several areas of care and research. Working closely with the doctors
who would direct the various programs, the architect designed a state-of-the-
art medical facility and a splendid building that would serve as a symbol for the
hospital and as a landmark for the city.

On the architect’s recommendation, a local contractor was retained to begin

pricing the preliminary plans. As the drawings and budgeting progressed, the
hospital was confident enough to apply for bank financing, and the bank, on
the basis of the contractor’s estimates and the proposed bond issue, agreed to
make the loan.

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Then the contractor presented his final budget. To the board’s surprise, the
estimate had grown by $3.5 million—and the detailed construction drawings
still weren’t complete. The contractor claimed the architect was upgrading the
quality and scope of construction. The architect insisted he was only complying
with the growing wish list of the trustees, doctors, and marketing experts hired
by the board. But the bond issue was based on the original budget, and it
wasn’t big enough to accommodate the higher price. The hospital could not
proceed. The trustees and the doctors held a meeting.

The doctors insisted they had added very little, and they refused to eliminate
any of the medical features designed into the building. The trustees were
convinced that the overall increase in scope was much smaller than the new
price indicated. Everyone suspected the contractor of taking advantage of the
hospital. The chairman decided it was time to act.

“In my industry—financial services,” he reasoned, “all services are bid for. We

give all aspirants a chance to say what they will charge. That’s the way to get
the lowest price.”

A local manufacturer on the board agreed. “I had one of these ‘trust me’
contractors do my warehouse on a time-and-materials basis, and he soaked
me good. He put his worst workers on the job, he didn’t fight for purchase
discounts, and he did everything he could to get costs up so his fee would go
up. Let’s not make the same mistake I made.”

So the project was put out to bid with no modifications in scope and still
without completed blueprints and specifications. Five companies submitted
bids. The hospital’s chief financial officer awarded the contract to a builder
whose price was within the original budget. The original contractor was banished
in disgrace, despite his protestations that his estimate was the right price for all
the work the hospital would need.

Conflicts developed at once. The new builder had assumed that the space to
be renovated would be vacated to work in, but the hospital couldn’t do that.
The builder threatened to stop work, so the board caved in and gave him an
increase. The architect and the contractor fought constantly over interpretation
of the drawings and specifications. The trustees, distracted by questions of
finance and marketing, did not always make timely decisions. The contractor

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cut every possible corner to hold down costs, and the architect overruled him
again and again.

Just as the building was nearly finished, the board was shocked to receive a
huge change-order request from the contractor alleging inaccurate specifications,
changed conditions, and decision delays by the owner. The hospital refused to
pay. The builder shut the job down and placed mechanic’s liens on the property.

This was where the project now stood. The members of the board—successful
local businesspeople, educators, and public servants—were angry and
embarrassed; the architect was bitter; the original contractor was full of I-told-
you-so’s for anyone who’d listen. The chairman of the board was still baffled.

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