Fog Creek Software
Discussion Board




fixed price contract

Hello to everyone.

I have a small business where I sell a few products I have created. The business provides a modest income. When I have time, I also do a limited amount of consulting, which I have always done on an hourly basis. I have heard enough horror stories to eshew fixed price contracts, athough for the right potential payoff I would consider it.

One of my products is a video compressor that works in real time and requires very little computation compared to other methods due to extreme mathematical cleverness on my part, and also what I'll call 'secret knowledge' of visual perception. I have not patented it nor do I want to, I prefer to keep it as a trade secret which I enforce by only selling it as a custom chip where it's secrets are unlockable. Knowing how the decoder works doesn't give away any secrets.

One obvious use of the technology is for a remote sensor since it can run on very low power for extended periods of time, which is convenient for applications such as spy cameras.

Recently I was contacted by a small engineering firm, A, that is interested in my invention. A has been hired by a large well known firm known for its big government contracts, S. S in turn, has won a big to design a system for government agency N. Now, although S has the contract already, they know nothing whatsoever about the technology, which is why they hired A, a known specialist in much of the contracted system. And A can do most of the work, but the key part -- a video compressor with certain unusual and rare characteristics is beyond their ability and understanding to invent.

So that's where I come in to the picture -- they are quite anxious to use my algorithm.

I offered to, given the specifications, design a chip specific to their needs to do what they want, but A doesn't like that plan for two reasons. The first is that I would not be giving them the algorithm and thus they'd have to come back to me if they wanted any changes made. The second is that they don't want to pay me by the hour, but want a fixed price quote.

I don't really care for either of these restrictions unless the terms made it worthwhile for me. As it is, they are proposing a three phase plan:

1. I deliver a working prototype. This prototype would have to be adjusted to meet their needs and would have to meet stringent requirements perfectly. I have estimated it would take me 4-6 months to construct it at a cost of $30,000 for materials and equipment, plus about $15,000 in some miscellaneous labor costs involving hiring part time workers to help run my main business while I am working on this project. My consulting rate for this sort of work is $185/hr, so I figure $185,000 in consulting charges. This is if I was charging by the hour how much I think it would cost to develop. But there is uncertainty in doing fixed price. What is the markup I should apply to cover my risks? Firm A states that they will pay only upon completion and only if the prototype is satisfactory -- thus I will have to put $45k cash up front. Personally, I think THEY should pay the $45k in physical costs up front to ME, and I think my fixed price should be double my basic hourly estimate ($370,000) and I think it should be delivered in three payments of about $120,000 each spaced out at two month intervals. Does this seem reasonable? They state this is totally unacceptable and things don't work that way - they say the way things work is that they pay only upon completion and only if satisfied.

Upon evaluating the prototype, if they feel they are not satisfied with its quality (they have seen the quality of the base product, btw and know that it works, but they have additional requirements), not only will we not move to stage 2, but they do not pay me for the prototype either. I am just out of luck. Is this normal? They tell me this is how government contracts work. Personally, it seems I am being asked to assume great risks and costs and they are getting a free ride. I think the prototype delivery and the selling of the algorithm in step 2 should be 2 separate things and they should have to pay for the prototype as long as it meets their specs for the prototype.

In stage 2, they acquire the algorithm from me. I don't like this but I am ok for the right price. They are asking that I will guarantee the specifications and requirements I provide and risk sanctions if they are unable to meet them. I think a more reasonable arrangement would be that the algorithm is accepted as is. Their plans are to create a new piece of hardware merging my design with other hardware that I am not to be privy of the details of, all on one big chip. Someone else will do this work, presumably someone with a security clearance. I have no way of knowing the details of what they are doing and yet they want me to accept responsibility for the performance of the design that someone else does. This seems absurd to me. Have any other contractors run into this sort of thing? I think my responsibility should end when I deliver the prototype and the algorithm.

Regarding the algorithm, video compression is a field I have 30 years of experience in and what I have now is the result of mayn years of work. I estimate that there are 15,000 hrs invested in the development of what I now have. As long as I retain rights to the algorithm and they are merely licensing it, I think $1.5 million is a reasonable fee to reveal the secrets of the algorithm.

Here's how I want it to happen:

- payment up front to get started that more than covers the costs I will incur.
- payments on a schedule, final payment upon completion
- cost much much much higher because they insist on fixed price
- payment made based on whether the prototype works according to specs and not based on if they feel it is adequate or suitable
- payment of the algorithm is made up front BEFORE I reveal the algorithm to them. If the prototype works to their satisfactoin, I sell them the exact algorithm used in it.

But they want to evaluate the algorithm after evaluating the prototype before making final decision on whether to license it. Since it is a trade secret ad not a patented ip, I am concerned that what is going to happen is they are going to get a free feasability study from me in the form of a working prototype, then take the algorithm and not pay for either it or the prototype and I will be out $45k cash and there won't be a damn thing I can do about it. I mentioned all this to them at A and they said that contractor S is a big reputable, honarable, honest firm and would never be involved in anything like that.

Also, they don't feel I need to meet with anyone from S, they say I'll be their sub-sub-contractor. They say S knows all about me and is eager to see me get started on this but S wants me to deal with A exclusively.

Se what do you guys with experience dealing with these Big Players think? I'm right to be concerned right? I should insist on big payments on front, right? They are lying when they say that it's always full payment only on delivery and acceptance? And what about my IP? The way I see it is that without a patent, there's nothing at all to prevent them from using my algorithm for whatever they want, regardless of any stipulations to the contrary in a contract, by virtue of the fact that they are Big Players who employ dozens of lawyers with $1800 suits.

Should I trust them? Should I run like hell? Should I stand my ground? Tell them to piss off?

I don't need the work or the money but I wouldn't mind doing the project if I can be certain I won't be shafted.

Tesla
Friday, August 29, 2003

No - don't trust.

AC
Friday, August 29, 2003

Reminds me of a conservation I had with the president of small automation company SmallCo. SmallCo was asked by big, honest, reputable company BigCorp to build a machine to automate a process. SmallCo was to deliver a prototype to BigCorp, and would be paid for the machine if it passed BigCorp's equipment qualification process. The prototype was delivered but failed BigCorp's qualification process for some dubious reasons.

SmallCo was not paid one dime for their prototype. Even worse, BigCorp kept the prototype and SmallCo didn't have the deep pockets needed to fight them over it. Last he heard, BigCorp was using it in production anyway.

I wouldn't run away from the deal, but I would stand my ground if I were you. Thomas Edison is remembered as a great inventor, but primarily he was a great businessman. He always got the money up front.

Nick
Friday, August 29, 2003

IMnsHO, you should absolutely NOT do work for them that requires significant up-front investment of time and money on your part with no guarantee of remuneration.

It sounds to me like *you* have the clear upper hand in negotiations here -- you don't appear to need them, whereas they certainly seem to need you. Not that you can set whatever terms you like, but you should decide what's realistic and negotiate with your position of power in mind.

One thing you might try is putting together a proposal that describes a series of options -- hourly rate, fixed-price, licensed -- each of which meets your requirements. Spell out terms: If you do fixed price, you want 50% up front, 50% on acceptance, or whatever. Give them what Weiss in "Million-Dollar Consulting" (superb book, btw) calls a "choice of yeses" (i.e., instead of deciding whether to work with you or not, they decide how to structure the relationship with you).

Also, given the amount of money at stake here, the apparent recalcitrance of the other party, and the trickiness of intellectual property issues, I would strongly urge you to see a good IP lawyer NOW. S?he might have some good suggestions for how you can structure a relationship so your interests are protected, and you'll certainly want h(im|er) to review whatever terms you agree upon before you sign.

Matter of opinion here: These guys frankly sound more like they want to take advantage of your specialized expertise rather than establish a mutually beneficial relationship. I would be wary. I'm not suggesting at all that you should walk away from this, just that you should be confident your own interests are being fully represented. That's something lawyers can be really good at, of course.

P.S. Lest it sound like I'm a flack for your local bar association, I should mention that I happened to have spoken with my lawyer this afternoon about an engagement I've been negotiating, and once again I was jazzed by how earnestly he considers my interests in contracts, etc. I'm not an adversarial person by nature, but it's great to have somebody like that on your side to make sure you're not getting shafted. Joel's article from a while back on finding office space in Manhattan had a great example of how valuable good lawyers can be (his said something like "wow, I love that paragraph and want to use it with some of my [landlord] clients -- but no way are you signing it"). I may be disappointed by the snowballing litigiousness of American society, but I'm certainly glad I've got someone smart and knowledgeable watching out for my interests.

John C.
Friday, August 29, 2003

Don't trust. Regardless of S reputation, A will never pay you in full. I'm in Germany, but I don't think matters are any better where you are. In fact, I was in the court once dealing with very similar situation - big player S, known A without special knowledge in our field. A just refused to pay the next rate after three monthes of our work. Then we stopped to work. Then we sued them, and they sued us. We even partly won, but never got all the money.  I was happy the contract was relatively small - compared to yours. The most idiotic thing here is the project was 99% ready, S liked it, A liked it, everybody liked it. At the end S could not finish it themselves, got absolutely nothing, and had to start from scratch somewhere else - so I've heard later.

Due to the nature of my work (web applications) I'm often contracted by some design or marketing agencies representing big players, and have to offer fix prices - to some extent, for very carefully written specifications on my part. Changes are paid per hour then. So A is probably right on this - it may be unusual to pay you at  the hour basis for such a big thing. However, you're right on anything else - double your estimate and so on.

Igor

IK
Friday, August 29, 2003

I hope you haven't signed anything with A yet.

Don't trust. You have no reason to trust, and the only thing to be gained by trust here is your own loss.

Contact an attorney. Ask around for a referral to a good attorney that HAS EXPERIENCE in these kinds of matters. You need an airtight NDA and contract.

Do NOT release your algorithm. Be prepared to walk away. Trade secrets *can* be enforced in court, but only to the effort you put into protecting them.
http://gemini.lib.purdue.edu/instruction/gs175/Spring99/gs175d/lesson_vi.html (Trade Secrets)

Agreed on "present them with options" but honestly, unless they're willing to pay enough for you to retire, don't put the algorithm on the table. At all.

Finally, watch all the shells while negotiating - try to keep the option open that if talks fall through with A, you can go directly to S and take the work.

Philo

Philo
Friday, August 29, 2003

I second Philo, dont trust.
and see an IP lawyer as soon as possible, I understand your reluctance but the time has come.

If you can afford it, get your lawyer to do the negotiations.  You will possibly lose the work that way, but you should end up protecting yourself and your income.

_dont_ try and do the negotiations yourself, particularly if you dont have a partner or someone you can have with you while you deal with them.

FullNameRequired
Friday, August 29, 2003

Tesla, your instincts are correct. What you really need is a business person who understands your business, rather than a lawyer as such.

FWIW, here are some examples of similar situations I've encountered over the years:

1. Like you, I had developed some significant technology that Big Co became interested in. Big Co asked to examine the source code. I refused.

A few weeks later, a small business partner of Big Co offered me a sub-contracted job that could have been filled using my specialised technology. Since I didn't want to give away my technology, I developed a sort of hard-coded solution. When the small business partner saw how I was filling the contract, they tried to pressure me into working faster, which I later realised was an attempt to trick me into using, and providing, my technology. I didn't do that.

2. In another situation, much like yours, I was sub-contracting to a Medium Co and providing important technology. Medium Co tried to maintain that they were helping me create markets for my technology, and that thus they shouldn't be paying me. In fact, Medium Co gained lots of benefit and revenue from my contribution, and they did end up paying me for the consulting work.

Wig
Friday, August 29, 2003

"What you really need is a business person who understands your business, rather than a lawyer as such"

[sigh]

No, no, NO

In times gone by, there was an appellation of respect for attorneys - they were called "counselor." This was for a reason - they weren't just "the guy who knows the law" - they were people that you went to for advice in legal situations. They could give advice regarding business (or other) decisions with full knowledge of the law.

Many lawyers still fill this role, and a wise client will take advantage of it. Find a LAWYER who knows the business. Get his or her ADVICE. If you find a business person who knows the business, it's entirely possible they could advise you into a legally indefensible position.

Trade secrets are a risky business - it's like keeping a genie in a bottle. You have to work very hard to keep the secret, both practically and legally, but it can provide a significant payoff if done right.

Philo

Philo
Friday, August 29, 2003

If you are dealing though A with S, you have to start treating A as being S, but with added risks of financial instability. Be very carefull dealing with S (or A).
Get a person involved that has experience in these matters. This will cost you around 1.500$ a day. You might be able to strike a deal where you pay less but with a major % bonus on successfull conclusion.
You will discover the joys of many ploys. Do NEVER trust S. Everything that is not in writing does not exist, the next meeting there will simply be another set of people from S that will have no knowledge of anything said by the previous team. Every word written has the value of its most usless interpretation.

Good luck.

Just me (Sir to you)
Friday, August 29, 2003

Philo,

I have to disagree. I'm quite close to some people who do these dealings for a living, and while lawyers are on the team, they are not the ones leading the negotiations.

Just me (Sir to you)
Friday, August 29, 2003

Philo, I also disagree strongly. I actually have been involved in these things and I've found the lawyers have to ask lots of questions to understand the issues. Even when they almost understand, they're not the ones who propose the important solutions.

An experienced business person will know the law in these areas.

Wig
Friday, August 29, 2003

For Just Me and Wig - I'm curious about your experience in getting business advice from these power players. Three thoughts come to mind:
1) My experience in getting advice from CEO's or VP's is "I'm too busy to help you run your business - try the local chamber of commerce" but maybe it's just me. :)

2) You go to CEO Advisor guy, explain your situation. Lay out your plans, tell him what you're thinking. He asks some questions about your business, maybe some info about your algorithm. He says he's pretty sure he can help, and will schedule a meeting with you next week. Never mind that he's on retainer to advise company A... Or maybe company A sues the original poster for patent infringement and calls CEO Advisor guy to the stand to testify. He's got to tell everything he knows.

3) "Just get any middle management guy to help you plan your company's IT infrastructure. He'll know enough about networks and databases to do it right"
Do these high-powered omniscient business beings have lawyers? Ever wonder why?

Final thought - a wise CEO, when approached and asked about negotiating a contract with protections for trade secrets, will say "You really need to talk to an attorney."

Philo

Philo
Friday, August 29, 2003

Business people have their place, but there are simply times when what you need is a lawyer, and if you can afford one that other law firms are scared of, this is a good thing.

My wife had some troubles with her place of employment a couple of years back, they were lining her up to take the blame for some seriously bad behavior on their part.

I/we were very lucky because (thanks in good part to my income) we are able to afford a _good_ lawyer with experience in her area, we paid through the nose for him but it was worth every cent (the job itself wasn't worth saving by that stage of course, but watching him make those assholes eat their words was a beautiful moment), and it really gave me an understanding of what a _good_ lawyer brings to the table.
Good lawyers are trained to understand implications, to think of contingencies, if you get a good lawyer on your side it will be the gift that keeps on giving.

Dont piss around with business people who may or may not know what they are talking about and who do not do this kind of thing for a living, you sound like you can afford a _good_ lawyer so hire one, you wont regret it.

FullNameRequired
Friday, August 29, 2003

Let me also point out the difference between a good lawyer and a not-so-great lawyer is like the difference between a software guru (who can deal with clients, pull requirements from offhand comments, thinks in database schema, writes their own stored procedures, writes and comments good code, etc, etc) and someone who can bang out an ASP webform that mostly works.

I suspect most lawyer horror stories are from the latter.

It's really not that hard to get a law degree, nor a license. A license to practice law is like a software certification - it establishes a bottom line level of knowledge, but there is a huge blue sky above that level where talent can range.

Philo

Philo
Friday, August 29, 2003

Philo,

I was not reffering to getting some "CEO" to do the bidding for you. In other sectors of the ICT world (e.g. telecoms) there are consultancy firms that are specialized in high value negotiations. They know their subject far better than the companies they work for, and have experience in leading extremely though negotiations. It is their business, not just some sideline or favor. These people tend not to be lawyers (although they know their specialty domain law quuite well). There are always lawyers involved, but not leading the negotiations.
I was (maybe mistakenly) assuming that this would also be the case in other tech sectors.

Just me (Sir to you)
Friday, August 29, 2003

Just me -
You can really hire a negotiator to handle the entire transaction for $1500/day? They *must* charge through legal fees, which makes your quote pretty disingenuous, doesn't it? ;-)

IOW, I believe you're talking about just the cost for the guy planning strategy and sitting at the table - he's not going to draw up a contract or draft an NDA; those are costs Tesla still has to pay (which could quickly eclipse the cost of the negotiator)

Philo

Philo
Friday, August 29, 2003

Thought this out, wanted to restate it (hopefully in a compromising fashion)

There are two issues:
1) Negotiations/strategy. You can get advice on this and do it yourself, or you can outsource. Obviously if you can get someone who's really gifted it may be worth your while to have them make the negotiations for you - you have to do a cost/benefit on this.

2) Legal issues. You cannot get around this. Whichever option you choose in (1), you still need a lawyer.

The two are definitely severable, but you might also find a package deal (like the negotiation teams Just me talked about). Or one might refer you to the other.

Does that make more sense?
Philo

Philo
Friday, August 29, 2003

You nailed it.

Just me (Sir to you)
Friday, August 29, 2003

Philo,a friend of mine runs a business doing telecom negotiations, the same thing that Just Me describes. He does all the negotiations, and he does not have a law degree. I believe he just has a BA in communications. He is also 6 foot four, athletic, and very intimidating.

He works on a comission basis...what he does is help firms get better prices on their telecommunication contracts. He identifies companies that are being overcharged for voice and data service and then he offers to re-negotiate their contract for 30% of the savings. He tends to identify companies that are being overcharged in the _millions_ of dollars, so he makes TONS of money. The best deal he closed last year, he personally took home close to $700,000!  (he considers $20K a month an unlivable wage, making me wonder why i wasted so much time taking math and CS courses!)


There are lawyers who work with him, but they are there to take care of paperwork and perhaps offer legal advice. And yes, the LAWYERS he works with during these negotiations make $1500 per day. He himself makes much, much more.

rz
Friday, August 29, 2003

ps: my apologies for derailing another post off topic

rz
Friday, August 29, 2003

Tesla, set up the contract with the company in a way that you don't have to trust them at all to get your money.

Basically, they pay, you do some work, they pay more, you do more work, etc.

Once everything in stages and pre-paid - then you can talk.

Small guys get shafted so many times, it ain't worth the risk to you to try to do it any other way.

Mr Curiousity
Friday, August 29, 2003

And it sounds like you sorta know this already, but it's okay to say "no" if you don't want to work with them.  You have all the cards: you have tech they don't, and you don't need their money.  That makes it their job to make you happy.  (=

Sam Livingston-Gray
Friday, August 29, 2003

"I mentioned all this to them at A and they said that contractor S is a big reputable, honarable, honest firm and would never be involved in anything like that."

You know, I get the feeling you were not completely comforted by this response.  Sure sets my alarm bells ringing.

You're playing out of my league here, so what do I know, but it sure sounds to me like these guys have their own secret business plan that has "steal Tesla's tech" on page 3.  On the other hand, you seem to be a bit more cautious than your namesake.  Good luck.

Matt Conrad
Friday, August 29, 2003

Tesla,

What you are experiencing is a fairly typical bullying. In a prior life my employer had to deal with a Fortune 1 company.  They love to play these bully games, to put all the risk on your part. Chances are good that it's a bluff.

If they really want your product, they'll agree to a regular payment schedule. This is a very normal arrangement.

The lawyer advice is dead on though. You need an expensive one at your side. Somebody who's used to squeezing big companies by the balls until they cry uncle.

Clay Dowling
Friday, August 29, 2003

rz: you write about your friend that "what he does is help firms get better prices on their telecommunication contracts". The difference between his negotiations and the original poster's is that people buying phone service have nothing to lose (beyond what they're already paying), whereas the original poster has the fruits of decades of work, plus considerable time and cash, at risk.

Bigger risk -> you need bigger risk protection.

Exception guy
Friday, August 29, 2003

Philo, you asked about the experience of Just Me and me  in getting business advice from what you describe as "power players". You give examples from your own experience in asking advice from CEO's and VP's.

I guess I am the power player you have in mind, so that removes the problem of getting my attention. I've had several of these negotiations in my own right - for my company, and also while I was working in strategic roles with different companies. I did well in them.

Wig
Saturday, August 30, 2003

Wig - so how come your advice was "find a power player" and not "drop me a line"?

Philo

Philo
Saturday, August 30, 2003

Thanks for everyone's useful advise.

I agree completely on the lawyer issue. I do not live near a major city so it'll be hard finding one (by one I mean a well-qualified IP attorney) without having to do a lot of flying back and forth.

One thing I don't want to do is blow cash on attorney's fees and travel expenses for something for which I am not already receiving income. Thus, negotiating licensing when it is uncertain whether any agreement is even possible seems foolish. Would be OK if I was some big company and had an in-house attorney and all that but that's not the situation. The reason I am a small business like I am is because I got screwed over too many times in the past and I just don't want to get involved in that sort of thing again.

On the negotiation issue, I do know some people and I do have access to a couple retired successful CEOs, so it seems to be time to contact them and see if they have advice or want to assist.

My starting position was no-disclosure and after this discussion, I have gone back to that starting point. I don't want to reveal secrets to this guy. So I'll present him with options that don't involve that. He'll probably refuse but that's fine with me as I am plenty busy already.

Tesla
Monday, September 01, 2003

*  Recent Topics

*  Fog Creek Home