PJM400 MOD7 Discussion post peer responses
Please respond to both POST1: and POST2: in at least 250 words. i have included the original post as reference.
From among the required or recommended readings and at least one credible, peer-reviewed outside source, answer the following.
- Why do contracts include incentives?
- When is it best to use an incentive (identify a minimum of two specific circumstances under which the use of incentive elements in the contracts are beneficial or necessary)?
- How are contracts used to transfer risk (identify two specific circumstances and provide an example for each)
Contracts may include incentives. These incentives are intended to reward or punish sellers depending on how they perform (Baily, Farmer, Crocker, Jessop, & Jones, 2015). Sellers are rewarded with an incentive if their costs are reduced and/or performance is improved. In contrast, sellers would be punished is their costs were increased and/or their performance worsened. These incentives encourage sellers to manage their performance and complete the contracts.
It can be beneficial to use incentives in contracts under certain circumstances. These circumstances include the following situations:
- Amazon, Walmart, and CVS are including bonuses and temporary pay hikes in their employment contracts to retain current employees and hire new employees. (See links below references)
- A construction company enters into a Fixed-price Incentive contract to build a large, multi-phase project. The company would be paid a fixed price for each phase of the project. It would also receive an incentive award if they met the incentive terms (under budget, early completion, etc.) for the phase (Eriksson, 2017).
Using Contracts to Transfer Risk
Contracts can be used to transfer risk. There are several ways in which risks can be transferred. Two of these ways include the use of an indemnification clause and the use of a contract breach. CFI Education Inc (2020 states that an indemnification clause ensures that potential losses will be compensated by the opposing party. In comparison, a contract breach occurs when one party breaches the contract due to non-justifiable reasons. If this occurs, the risk and related costs are transferred to the offending party (CFI Education Inc, 2020).
- PCL Construction may include an indemnity clause in the contract which indemnifies the company from the responsibility for loss or damage caused by contractors during the project.
- AAA Maintenance Co. does not maintain the outside of the BBB and a client is injured due to the lack of maintenance. Due to a breach of contract, AAA Maintenance Co. would be responsible for the risk and any related costs.
Baily, P., Farmer, D., Crocker, B., Jessop, D., & Jones, D. (2015). Procurement, principles, & management (11th ed.). United Kingdom: Pearson (Intl) Inc. Hardback ISBN: 978111813009
CFI Education Inc. (2020). Risk transfer. Retrieved from https://corporatefinanceinstitute.com/resources/kn…
Eriksson, P. E. (2017). Procurement strategies for enhancing exploration and exploitation in construction projects. Journal of Financial Management of Property and Construction, 22(2), 211-230. doi:http://dx.doi.org.csuglobal.idm.oclc.org/10.1108/J…
Target, Amazon, and Walmart:
Contracts in the time of coronavirus: Force majeure and frustration:
Edited by Marybeth Dunlap on Mar 23 at 11:06am
Why do contracts include incentives?
Contracts will include incentives to either secure a new business relationship or maintain and improve an existing one (Kelly&Yang.2017.). These incentives have the ability to encourage better performance. However, poor performance can lead to incentives being taken away and the supplier or organization being penalized. To put it into terms that I can understand better, a running back in the NFL will have a base salary provided that he makes the team. Based on his position he is expected to preform at a very high level as he is playing a position that generally scores numerous times a season. The incentives in his contract are usually based on the number of times he scores and the number of rushing yards he totals during the season. More touchdowns means more commas and zeros added to his pay. This usually leads to a higher paid contract the following season.
When is it best to use incentives?
It is best to use incentives when as soon as the desired outcome is produced or the goal has been reached. The longer a group or organization must wait for their anticipated incentive the more the momentum and excitement is lost for any future projects.
- NFL players performance during the season
- When a sub-contractor completes the services that are required a head of time.
How are contracts used to transfer risk?
Risk transfer involves passing the risk to a third party. The risk is still there it just gets transferred to a third party to manage. Examples of contracts being used to transfer risk would be things like property insurance, or Fixed price contracts.
Kelly, C., & Yang, J. (2015). Improving the bottom line.Internal Auditor, 72(1), 54.