MGMT 610 Week 5 DB Forum 3 Example

Discussion Board Forum 3: Thread and Two Replies

MGMT 610 Risk Management, Discussion Board Forum 3 (thread and two replies)

Thread by [Student Name]

The prompt, the hospital's project and the classmates' posts are composites standing in for the course's own forum; the textbooks, the peer-reviewed studies and Scripture are real; the requirements follow Liberty's public course guide for MGMT 610.

Thread

Our 25-bed critical access hospital in the Nebraska Sandhills spent two years raising money for its first MRI. Our current imaging consists of a mobile MRI trailer that visits two days a month, so patients with back injuries or suspected strokes travel ninety miles to the nearest scanner. The board chose a prefabricated MRI suite from a modular imaging vendor under a fixed-price contract of $2.9 million, because the foundation that had pledged most of the money wanted a firm number. The contract covered the module, shielding, installation and foundation. Three days into site work, the vendor's excavator struck groundwater four feet down. The contract's differing site conditions clause placed unknown subsurface conditions with the owner, and the dewatering, a raised foundation and a two-month delay added $310,000, which the hospital paid from its own reserves.

The PMBOK Guide describes fixed-price contracts as placing more risk on the seller and cost-reimbursable contracts as placing more on the buyer (Project Management Institute, 2017). Bajari and Tadelis (2001) explain why the choice should depend on the work. In their model, fixed-price contracts give sellers strong incentives to control cost but make changes expensive to negotiate, so they suit simple, well-defined projects, while cost-plus contracts suit complex projects in which changes are likely. Our project looked simple, a module set on a slab, but its foundation was not well defined because no one had drilled a boring. We bought a fixed-price contract for a project whose most uncertain part sat outside the price. In effect, the hospital paid the vendor's risk premium for the parts of the work that were predictable and kept the one risk that was not.

Ward et al. (1991) argued that a risk belongs with whichever party can best control or absorb it, and that pushing a risk onto a party with no control over it mostly buys higher bids or disputes. The groundwater risk could have been managed by either party only through investigation. A $6,000 geotechnical study before signing would have turned an unknown into a known, priced condition. Osipova and Eriksson (2013), studying two construction projects, found that joint risk management between client and contractor depended on collaboration and a willingness to share risk information, rather than on the formal contract alone. Our vendor's project manager later told us he had wondered about the water table but had not asked, since the clause protected his firm. Wilson (2015) treats procurement decisions as part of risk planning, and our plan had treated the contract as a substitute for one.

In Jesus's parable of the vineyard, workers hired early complained when latecomers received the same wage, and the landowner replied that he was treating them fairly, because a denarius was the wage they had accepted (English Standard Version Bible, 2001/2016, Matthew 20:13). A contract binds both sides to what they actually agreed, which is why a buyer must know what it is agreeing to. Our hospital kept its word and paid, but we now require a site investigation before any fixed-price construction contract is signed, and our risk register lists, for every contract, which risks the clauses actually leave with us.

Classmates: have you seen a contract clause send a risk back to the party that thought it had transferred it?

Reply to Olivia

Olivia, your thread argued that owners should use fixed-price contracts whenever possible, because the county you work for saved money on three road resurfacing projects that way. Your results make sense for that kind of work.

I would add a limit to the rule. In the model of Bajari and Tadelis (2001), a fixed price earns its keep when a project can be specified completely in advance, as resurfacing usually can. When a project is complex, the cost of renegotiating each change can outweigh the savings from strong incentives, which is why their model predicts cost-plus contracts for complicated work. Your county's planned courthouse renovation, which you mentioned at the end, may be a different case: old buildings hide conditions no drawing shows, from undocumented wiring to lead paint behind plaster. On that kind of project, a fixed-price bidder either prices every hidden condition into the bid or files change orders when they appear, and the county pays either way. The PMBOK Guide also lists hybrid forms, such as fixed price with economic price adjustment, that can share specific risks such as material escalation (Project Management Institute, 2017).

Wilson (2015) places procurement inside risk planning, which suggests choosing the contract after the risk register is drafted rather than before. Would the county consider a guaranteed maximum price with a shared contingency for the courthouse instead of a pure fixed price?

Reply to Sam

Sam, your account of the time-and-materials contract for the software consultants at your insurance company was candid: a twelve-week integration that ran to twenty-one weeks, with the consultants billing every hour. You concluded that time-and-materials contracts should be banned.

I think the problem may have been how the risk was allocated rather than the contract type itself. The allocation principle of Ward et al. (1991) asks who could actually control each risk. Under your contract, the consultants controlled the pace of work but bore none of the schedule risk, while your company bore all of it but could not direct the work day to day. A not-to-exceed cap or milestone payments, both common additions to time-and-materials contracts, would have given the consultants a stake in finishing. The PMBOK Guide also notes that time-and-materials arrangements suit work whose scope cannot be defined quickly (Project Management Institute, 2017), which may describe the discovery phase of your integration but not its later build.

Proverbs warns that a slack hand causes poverty while a diligent hand makes rich (English Standard Version Bible, 2001/2016, Proverbs 10:4). A contract can reward diligence or quietly reward slack, and a well-meaning team can drift toward whichever one the contract pays for.

Did the statement of work define milestones that payments could have been tied to?

References

Bajari, P., & Tadelis, S. (2001). Incentives versus transaction costs: A theory of procurement contracts. The RAND Journal of Economics, 32(3), 387-407. https://doi.org/10.2307/2696361

English Standard Version Bible. (2016). Crossway. (Original work published 2001)

Osipova, E., & Eriksson, P. E. (2013). Balancing control and flexibility in joint risk management: Lessons learned from two construction projects. International Journal of Project Management, 31(3), 391-399. https://doi.org/10.1016/j.ijproman.2012.09.007

Project Management Institute. (2017). A guide to the project management body of knowledge (PMBOK guide) (6th ed.).

Ward, S. C., Chapman, C. B., & Curtis, B. (1991). On the allocation of risk in construction projects. International Journal of Project Management, 9(3), 140-147. https://doi.org/10.1016/0263-7863(91)90038-W

Wilson, R. (2015). Mastering risk and procurement in project management: A guide to planning, controlling, and resolving unexpected problems. Pearson FT Press.