Ex postadaptations and hybrid contracts in software development services

Abstract

We follow the recent literature on ex post adaptations in procurement and argue that highly volatile specifications result in multiple variations of fixed price (FP) and time and materials (T&M) contracts. Specifically, placing a cap on specification change in FP contracts prevents specification volatility, similar to the way that placing a cap on the price in T&M contracts prevents price escalation. We argue that these hybrid mechanisms are particularly important in software development contracting, a new critical business capability involving frequent and costly ex post adaptations to specification change. The level of completeness in these contractual archetypes is hypothesized to be determined by contracting costs and benefits, where costs are related to project uncertainty and benefits are related to the likelihood of vendor opportunism. We test this hypothesis with a unique data set of 270 software development contracts entered into by a leading international bank. The analysis confirms the existence of multiple hybrid contracts that mitigate both price escalation and specification volatility. It also shows that contracting costs and benefits explain more variance in contract choice when these hybrids are included, uncovering the detailed mechanisms used to curb opportunism when the vendor is less familiar to the client.

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