Software development contracts: The impact of the provider's risk of financial loss on project success

Contracts differ in the extent to which software providers risk financial loss in the case of cost overruns. In this paper, we hypothesise that an increase in the provider's risk of financial loss is related to an increased rate of problematic software projects. The hypothesis is tested by comparing software projects using target-price contracts with and without an upper limit on risk sharing. These two contract variants differ mainly in the provider's risk of financial loss. If the provider's risk of a financial loss makes a difference, we would expect that projects using target-price contracts with an upper limit on risk sharing would perform worse than projects using target-price contracts without an upper limit on risk sharing. Data were collected from 24 software professionals who had project experience with both contract variants. The software professionals were asked to assess the success of their last projects when using each of the two contract variants and their general experience with using them. We found that projects using target-price contracts with an upper limit on risk sharing were, on average, less successful. In addition, the respondents' general experience with the two target-price contract variants suggested that including an upper limit on risk sharing is related to less provider focus on delivering client benefits and with more client effort spent on project administration and monitoring. We conclude that placing more of the financial risk for cost overruns on the provider side tend to increase the likelihood of project problems.