The Iron Triangle – A great tool for successful Procurement and Contract Management

February 15, 2014

How do you distinguish if you pay too much? What are the elements you need to have in mind when putting together a deal?

There may be a lot of books and literature that describes this point. Nothing I have found though, makes this clearer than the concept of the Iron Triangle.

The Iron Triangle was part of a presentation by Sara Cullen at an IACCM workshop in Melbourne last year (you can find this concept in her book Outsourcing: All you need to know).

After hearing about this concept, I found that I was using it in discussions with colleagues more and more and that it was very useful to clarify situations and issues.

So, I thought I’d share it with you along with some tips on how to avoid been caught in what is called the “Winner’s Curse”.

Screen Shot 2014-02-13 at 9.43.15 pm

THE EXAMPLE

Sara, in her book, mentions the example of a retailer’s IT department (the Customer) who chose to go to tender for the data centre operations placing big emphasis on the price, on the belief that the services and the providers themselves were undifferentiated. So, the lowest bid (30% below the second lowest) won the tender. Value for money was not assessed or thought it was of importance.

Very quickly in the deal though, scope and price variations became the norm. KPIs were not achieved as these had been set up as targets and not as minimum standards and the Customer had not dedicated time to develop an SLA that was customised to the Customer’s needs.

Additionally, the Customer had now to dedicate a full resource to variation management. Demand peaks had not been accounted for within the tender price and so, even more resources had to be acquired. The story goes on.

So, as you can appreciate the total cost of this contract was very high. Actually, Sara reports that it was higher than the highest bid and the Customer was constantly preoccupied with fighting fires rather than adding value.

This a typical case of what is called the Winner’s Curse.

THE IRON TRIANGLE AND THE WINNER’S CURSE

To better understand what happened, we have to look at the concept of the Iron Triangle (picture above).

The Iron Triangle reflects the basic three elements of a successful deal. These are:

  1. Scope – what the products / services are.
  2. Performance (Quality) – what standards are required for the products / services
  3. Price – what price will be paid for the products / services

Focusing on the Price levels for now, this concept depicts three different price levels with the analogous levels of Scope and Performance (Quality).

1. The Winner’s Curse – This is the price a bidder will bid in order to win a tender. (P1)

2. Price to do – This is the price required to do the job including a reasonable margin (P2)

3. Price to act in Customer’s favor – The highest bid of all which corresponds to the highest quality and scope (considered in Customer’s favor) (P3).

In the above example, what the IT department (the Customer) failed to understand is, that selecting the vendors based on the P1 price level (the Winner’s Curse) means that the Provider needed to cut corners to recover its cost and potentially make a margin.

On the other hand, the expectation the Customer has in terms of Performance (Quality) and Scope usually resembles the corners of the Triangle corresponding to price level P3.

This means that the eventual triangle the Customer would require consists of the highest Quality and Scope levels but the lowest price. This results in a skewed triangle and is unsustainable.

Hence, what ensued the deal in the above example was the breakdown of the relationship and the spiraling of costs.

So, reflecting on the Iron Triangle, sourcing should be a search for the best value for money deal, taking into account the Scope, the Performance and the Price from the start.

TIPS TO AVOID BEEN CAUGHT IN THE WINNER’S CURSE

So, what are some tips to avoid been caught in the Winner’s Curse?

  • Be informed about what you want (specifications), how you want it delivered (quality), what value-additions are required (if any).
  •  Be in the know, from a Total Cost of Ownership (TCO) perspective e.g. estimate the transition costs for changing suppliers (should you want to add them in the mix) etc
  • A deal made must include clarity around these three items Scope, Quality and Price. Be sure to cover all of those from the start.
  • Have a variation process agreed.
  • Have an exit strategy should things go wrong.
  • Know the triangle you are in at every deal and prepare for any shortcomings if in fact you are forced to go for a winner’s curse.

Do you know what triangle you were part of the last time you did a deal?

Image courtesy of Sara Cullen / www.whiteplumepublishing.com

Filed under Category Management, Contract Management, Procurement Tagged with , , , , ,

If you want something complex done well, give it to a busy person!

December 13, 2013

We have all heard the phrase “If you want something done, give it to a busy person”. We all felt that there is some truth in it.

Research done by Dijksterhuis and van Olden recently seems to take this insight to another level.

The research was performed on how Decision Making and the likelihood of  Regret are linked and produces some very interesting results. Let’s look into it.

THE EXPERIMENT

As mentioned in Richard Wiseman’s book 59 Seconds, a few years ago Dijksterhuis and van Olden conducted a study whereas, subjects were shown five posters and were asked to use three different techniques to make a decision. At the end of this process the subjects were given the poster of their choice and a month later the researchers called them and asked them how they felt about their decision and what amount of money would it take to part with their originally chosen poster. The results are surprising.

At the time of the experiment the researchers broke the subjects into three groups.

  1. The first group was asked to immediately choose the poster they liked the most.
  2. The second group was asked to study the posters well, list what they liked and did not like about them. Only then, to make a decision and choose a  poster.
  3. The third group was quickly shown the posters and then they were asked to do anagram puzzles for 5 minutes. Only after this process, they were asked to choose a poster.

At the end of the experiment, all subjects from all three groups were handed over the poster of their choice, and then a month later they were asked how much they liked the poster then and how much they would sell it for.

Surprisingly, at the time of the experiment the subjects in Group number 2 (the ones that were asked to carefully consider the pros and cons) were the most confident they had made the right decision.

A month later though, it was a completely different story.

Group number 3, (who was shown the posters quickly and then did puzzles before eventually making a choice), were the most attached to their chosen poster and wanted more money to part with it.

WHY GROUP NUMBER 3? THE THEORY OF THE UNCONSCIOUS THOUGHT

The explanation of this behaviour is attributed to what is called, the theory of the Unconscious Thought.

A good summary of it can be found here and below.

Unconscious thought theory (UTT) was first presented by Ap Dijksterhuis and Loran Nordgren in 2006. UTT posits that the unconscious mind is capable of performing tasks outside of one’s awareness, and that unconscious thought (UT) is better at solving complex tasks, where many variables are considered, than conscious thought (CT), but is outperformed by conscious thought in tasks with fewer variables. This is a countercurrent position, as most research on UT since the early 1980s has led to its being characterized as simple and incapable of complex operations. Dijksterhuis’ and Nordgren’s theory is based primarily on recent findings from a new experimental paradigms.

The interesting article, titled, The Beautiful Powers of Unconscious Thought by Dijksterhuis himself (here), elaborates on the facts and nuances of these important findings.

PUTTING THEORY IN PRACTICE

So, what does this mean in practice for everyday work life?

Well, I think that this data supports the position that managers, supervisors and organisations need to make an effort to fill the days of their teams with meaningful projects and try to engage them (ideas on how to do this can be found here and well as a method on innovation here and here).

Moreover, as mentioned here we have to move one step forward from being busy to becoming productive as, the key question is not if we are “doing” something but if we are “effective” in what we aim for.

Hence, the organisations need to create an environment conducive to best utilise the theory of the Unconscious Thought aiming of course the more complex of projects. I trust that more research will be done on these important findings in the future that will verify and expand our understanding in this important field.

How did you handle your last complex task allocation?

Image of Ap Dijksterhuis courtesy of Radboud University Nijmegen / www.ru.nl

Filed under Category Management, Effective Communication, Effective Negotiation Tools series, Procurement, Productivity, Team Development Series Tagged with , , , , , , , ,