When working with a Client or Vendor, you’ll usually find 4 types of contracts:
Non-Disclosure Agreements (NDA)
Master Services Agreements (MSA)
Statements of Work (SOW)
Change Orders (CO)
You might encounter these as multiple documents or they might be consolidated into a single one. The image at left summarizes how contracts flow. It all starts with an NDA and then an MSA. MSAs can have multiple SOWs, and each SOW can have multiple Change Orders.
As a software manager, I strongly recommend becoming familiar with contract language and staying involved throughout the contract negotiation. Many red-lined versions will go back and forth between your two companies. It’s in your best interest to understand what these contracts are about and what you are signing up for, whether you are on the Client or the Vendor side.
/ / Key Watchouts
1. Stay involved: DON’T leave contract negotiations exclusively to Legal or (worse) to Sales. They have different incentives than you do. And at the end of the day, you’re the one on the hook to deliver or receive what was agreed upon.
2. Are you authorized to sign? Keep in mind that contracts are legally binding documents between two companies. Often, only a few people within an organization are legally authorized to sign contracts. So unless you have signature power within your organization, you should never sign a contract or any legally binding document. You could get yourself or your company in trouble.
Contract negotiations are usually tough, take a long time and they can make or break a project. In general, everything in life is negotiable, but the bigger company usually has the upper hand. If you are the Client and work at the bigger company, chances are you’ll be able to get away with a lot. Vendors will bend over backward to accommodate your needs and get your business. On the other hand, if you are a startup or smaller company and would like to work with a big established Vendor, then chances are, you won’t have a lot of leverage. Regardless of the situation, negotiation is key.
In a nutshell, here is what each contract covers, and key watch outs for each:
Non-Disclosure Agreement (NDA)
An NDA is an agreement between a Client and Vendor to not disclose proprietary information with anybody outside the company. As a Client, you’ll probably want to sign an NDA before you start sharing too much information about your product/project with a Vendor, and it’s common to sign NDAs with multiple Vendors before making a final selection. That way you’ll be able to share more information and get more realistic bids.
// Key Watchouts
1. Unilateral or mutual? NDAs can be mutually or unilaterally binding, meaning either one or both companies is prohibited from sharing the other’s info. No matter which way you go, the important part is to make sure you and your company are on the protected side.
2. Company or individual? Make sure that the NDA binds the company and not the individual employee. If you are the Client, you need the certainty that nobody on the Vendor side will divulge your trade secrets. If you are on the Vendor side, it’s a good idea to make sure nobody on the Client side can talk about your procedures and your “secret sauce”.
Master Services Agreement (MSA)
An MSA (a.k.a. Master Contract) defines how two companies will do business together. It is an umbrella contract that governs every SOW you undertake together. The MSA includes very important things like: payment terms, who owns the intellectual property (IP), marketing rights, limitations on liability, how to solve disputes, no solicitation of employees, warranties and so on. Very involved legal stuff. And chances are, both Client and Vendor side will have an MSA template they’d like to use. Which template to use is just the beginning of the negotiations. MSA negotiations can take weeks if not months. Make sure you account for this delay in your project roadmap or schedule.
// Key Watchouts
1. Ownership of IP: A key negotiation point is who owns the intellectual property created during the engagement. Some Vendors release all IP to the Client, while others just give a “perpetual license” but keep the rights. This allows the Vendor to take whatever they built for you and resell or reuse with other Clients. Make sure you understand your company policies and decide whether this clause is a deal-breaker.
2. Payment terms: Cash flow is important. As a Client, you’d like to pay as late as possible, but as a Vendor, you’d like to get paid as soon as possible. The standard terms I’ve seen are “net 30”. If you are on the Vendor side, keep in mind that the term starts counting from when the Client receives the invoice, not from when you sent it out. So “net 30” is really more like “net 35”, and that’s if they pay on time. Make sure your cash flow can take those hits. On the other hand, you can negotiate for shorter payment terms, for example “net 10” or “due on receipt” in exchange for a discount or other concessions. Everything is negotiable.
3. Marketing rights: For many Vendors, the ability to add a big name to their portfolio is invaluable. Many Vendor MSAs include a clause stating they can use the Client logo or advertise that they worked on a specific Client project. However, many Clients consider their chosen Vendors to be a strategic advantage, so they want to keep them secret and don’t allow for this clause. A common negotiation is to agree to a joint press release in exchange for a discount or better payment terms.
4. Non-Solicitation: MSAs usually include a clause to prevent Clients from hiring the Vendor employees. This is a way for the Vendor to protect themselves and keep the Client coming back for more. As a Client, if you really want to hire a person (and they want to come work for you), then you need to openly negotiate it with the Vendor. If you proceed without written permission from the Vendor, you might have a lawsuit coming your way for breach of contract.
5. Limitation of Liability: Usually, this clause states which side is responsible if the Client gets sued for work done by the Vendor. Some big companies have brutal liability clauses. For example, they might claim that the Vendor is liable in case the Client is sued by another company for patent infringement even if the Vendor had no idea about those patents. Basically it’s just a way for the Client to deflect all blame and use the Vendor as a scapegoat. This type of clause can bankrupt a company, so make sure you understand all the risks before signing. Possible solutions include modifying the language to add more protection for the Vendor and/or buying liability insurance that will be valid a certain number of years after the engagement is over. If buying insurance is the agreement, then it must be specified in writing in the SOW and the Vendor must show proof that they, in fact, bought that insurance.
Statement of Work (SOW)
Once the companies have agreed on an MSA (a.k.a. they agree how to work together), now it’s time to negotiate the specifics of the actual project. Each project will have its own SOW, but they all fall under the same MSA. Basically, the MSA defines the “how” and the SOW defines the “what” of the work.
The SOW defines, in detail: the deliverables, timelines, price, invoicing schedule, conditions and assumptions for any particular project. If you are on the Client side, this is what the other company is legally agreeing to deliver to you. If you are the Vendor, the SOW is what you are committing to deliver. Depending on your type of engagement, the SOW type may vary. The most common variations are:
Time & Materials: Client pays Vendor for a certain number of hours of work. Client has to cover any overage incurred to complete the desired deliverables. (see part 2 of this series)
Fixed Price: Client pays Vendor for specific deliverables. Vendor has to cover any overage incurred to complete the deliverables. (see part 3 of this series)
Retainer: Client pays a monthly fee in exchange for unlimited (or loosely limited) services. (see part 4 of this series)
Staff Augmentation: Client temporarily adopts a Vendor employee into their team. (see part 4 of this series)
Recommended post: Internet of Things: A Primer for Product Managers.
Change Order (CO)
As part of the MSA, companies often agree to a change management process, which includes Change Orders (a.k.a. Change Request Order). Change Orders document any changes in scope, budget, timeline, assumptions or any other deviation from the current SOW. A particular SOW can have many change orders. Once a CO is signed, the corresponding language in the SOW is no longer valid, and the CO becomes the new legally binding agreement for that part of the contract.
In general, change management is difficult to track. Often companies refrain from doing Change Orders because they fear the project will slow down until the companies finish negotiations. Don’t be discouraged by this. It is very important to document every change and have the matching contracts to back you up.
1. Keep it in writing: Handshake agreements are often a recipe for disaster. Doesn’t matter how big or small of a change, I strongly recommend creating a Change Order to document the new agreement. As a Vendor, I’ve been burned a few times by having handshake agreements and then having the Client side stakeholders change. Yikes! The new stakeholders didn’t recognize our agreements and wanted (rightfully so) to go strictly by what was in the contract. Can’t tell you how much trouble that was…
2. Be clear and explicit: COs (and any contract) should have little room for interpretation. Make sure the changes are quantifiable and deliverables are clear.
3. Zero-dollar CO: Not all COs have to involve money. It’s common to do “zero-dollar change orders” meaning that the change is in schedule, assumptions or content of the deliverables.
4. Bundle changes: If your company is too slow to sign contracts, you might save time by bundling many changes in a single Change Order.
Recommended post: A Product Management Framework for the Internet of Things.
The Bottom Line
Contracts are a complicated part of software management, so it’s important to get a basic grasp on them. The most important piece of advice is to make sure that all assumptions, deliverables, timelines etc are clearly stated in your contracts.
Avoid handshake agreements or additional comments in emails or other documents. Contracts are legally binding documents, and you want to make sure everything is in writing while the relationship with the Client/Vendor is still in good standing. If a problem arises, companies go with what’s on the contract. If it’s not there, you have no leverage at all.
So where do you go from here?
Now that you know the basics, it’s time to dig deeper into each type of contract: