Dealing with Toxic projects and contracts

Dealing with Toxic projects and contracts

One funny observation I made: whenever I am sharing thoughts and experiences with like-minded people, and especially when the conversation turns real raw and we go over some of the ugly truths of business, I often use the term ‘Toxic Projects’. This says a lot about my recent challenges, right?

What is truly interesting, though, is that as soon as I mention a toxic project to other IT professionals they all catch what I mean by that – yet everyone admits it’s the first time they have heard the term in the context of IT projects.

Now, we all understand the negative connotation the word toxic has in any context and we are all too familiar with concepts such as toxic assets. It is a popular term after all, particularly since the ominous year 2008.

A toxic asset is one whose value has fallen significantly and for which there is no longer a functioning market, so that such assets cannot be sold at a price acceptable to the holder. Companies are scared of toxic assets because, even with a massive strike of luck, it is a miracle to break even when getting rid of such assets. 

Therefore, dumping a toxic asset always means swallowing up a loss – and that’s if you get lucky, unlike in the 2008 financial crisis when mortgage-backed securities and some other “assets” could not be sold for pennies after they exposed their holders to massive losses.

The IT industry is no exception. All the work we do is either generating new intangible technology-based assets or is related to the success of an already existing asset (like service contracts). The problem is these assets might be quite toxic as well.

The eternal question: Why? 

On paper, getting new contracts is the best thing that can happen to us. Each new project is a reason pop champagne bottles open and celebrate, and every contract is supposed to be a “good guy” on the balance sheet.

However, what happens in reality and away from the Disney world some people live in can sometimes be very different.

Influenced by the current highly competitive environment, IT companies feel pressured by revenue and growth targets. As a consequence, IT firms are getting into aggressive (borderline desperate sometimes) sales and end up getting more than they bargained for. Oftentimes they decide to jump into new waters without having any relevant experience or expertise, which brings chaos down the road. On some occasions, the sole thing that’s responsible for the birth of a toxic project is failure to estimate a project properly.

A common error when estimating the cost of a project is not accounting for the warranty period. In Latvia for instance all public projects are a subject of two years warranty. Vendors can normally expect quite a lot of work to be done under the warranty and should therefore should allocate at least 10-20% of the total project budget for this warranty period.

However, in the last few years I have seen many projects that were re-baselined and seemed to be “successfully” delivered. What really happened was that the warranty budget was used to deliver the project and remained empty for the warranty period itself. This approach eventually caused great troubles to the involved companies.

Whatever the mistake may be, the ugly truth is: even cautious companies that think they know what they’re doing get trapped and find themselves involved in new deals that eventually prove to be toxic projects.

The fact of the matter is: all software consulting & services firms have items in their portfolios that are generating (or will ultimately generate) losses.

As an example, I have recently seen maintenance contract sold to a local public agency where company earnings per hour were only 2/3 of the actual cost to the company. This situation won’t improve over the years due to salary raises and team rotations, but the contract was signed for 4 years and there is no way to renegotiate the rates – so this is a prime example of a toxic project.

Such projects and contracts act as black holes and will absorb tremendous quantities of resources over time – not to mention the allocation of endless rescue budgets. In most cases, nothing good ever emerges out of a toxic project despite all the efforts and the longer the situation goes on the more damaging those contracts will become.

It truly is a lose-lose situation for everyone: the company, the employees and the client.

I have seen this first hand in Latvia, where the last round of European Regional Development Funding (ERDF) left many Latvian IT companies with portfolios full of very toxic stuff.

Many projects tendered out through the last period of ERDF turned out to be ‘mission impossible’ and had requirements that were in contradiction to each other and became impossible to fulfill. Due to nuances of how the public tendering system works, it is not easy to withdraw such requirements without cancelling whole project. These projects turned to be a nightmare both for clients and vendors and ended up consuming enormous resources (including lawyers fees).

What’s more troubling is that Latvian companies don’t seem to have learned their lesson, and considering how the preparations for the next period of ERDF funding are going (delays and huge chaos with how projects are planned and defined) I predict it will only be worse this time.

Finding your way out.

Talking about all of this surely brings up the question: what do I do with toxic projects and how can I avoid the issues that come with them?

Of course, the best case scenario would be to never get involved in toxic projects – but more on that later. Now, what should you do if you feel you have already been affected?

Before I dive into the specifics of it I want to give the first and most important piece of advice here: Do NOT think that new sales and getting new work will help your firm overcome current difficulties with a toxic portfolio – it’s only bound to get worse. I beg you, do not add more fuel to the fire!

Once we’ve gotten that out of the way, what is the next step to take? That would be identifying and _isolating_ toxic projects. Think about this: you need crisis management and firefighters for your toxic projects but this is not necessarily needed for all your projects. In fact this is very important to distinguish your toxic portfolio from the rest of projects.

You should first understand what we aim to achieve here. We want to understand and account for all the losses that occurred (or will occur down the road) as a result of having toxic projects in our books. We will then want to freeze those losses or potential losses by executing a new re-baselined plan.

Surprisingly enough, the first challenge to overcome here is to identify which of the projects are becoming a problem. Now, this is easier said than done and visible failures are obviously the first suspects, but even seemingly successful projects can generate losses and damage the organization – sometimes irreparably.

Everywhere in the industry, project managers and account executives are showing “miracles” and replanning sinking projects using dodgy methods so that they appear on-track or successfully delivered. Beyond the surface, though, the costs of those projects will be way beyond the initial estimation – and extra costs will have been covered by “borrowing’ from other budgets, either unconsciously or on purpose.

Audit is the answer.

So, what we want is to audit the budgets of ALL projects, and to challenge everything you will hear throughout the audit – since the real issues can sometimes not be identified with a superficial look.

Of course, the scale of the task ahead is huge: a detailed auditing process can be extremely time consuming even when it proves to be ultimately worth it. There are a lot of tricks and strategies to audit projects the right way and those can prove helpful in identifying project toxicity at early stages.

Nevertheless, one thing is certain: the moment you have identified what is toxic in your portfolio is a moment where new life for your company starts. You will have admitted the reality of the situation, you will have estimated the impact these toxic items have in your organization and it will be easier to have open communication on the subject across all the involved teams.

A long road lies ahead from the moment you execute your plan to the stage you have brought the toxicity of your overall portfolio down to zero. What will have changed is that from now on this is just a defined and expected cost in your budget – and a priority item for constant and thorough follow-up in your agenda, instead of a source of never ending bad news, conflict and unwelcome surprises for your company, employees and clients. 

So, over to you: what signs of toxicity you see around in your business?


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