Renegotiation of Software Outsourcing Contracts

Abstract

Fixed-price and time-and-materials contracts are commonly-used contract forms by clients in software outsourcing. The two parties, client and provider, usually renegotiate the testing time after system development occurs. This research investigates the impacts of such renegotiation on the client’s contract choice. Our analysis shows that under both contract forms, renegotiation can incentivize the provider’s effort, and this effect becomes more influential when the provider has higher bargaining power. Compared with a fixed-price contract, a time-and-materials contract can stimulate the provider’s effort based on the terms for monitoring and reimbursement. The results suggest that when the provider has high bargaining power, the client will prefer a fixed-price contract. But when the provider has low bargaining power and the cost of monitoring is low, the client will prefer a time-and-materials contract. When the provider has low bargaining power and the cost of monitoring is high though, the client will prefer a fixed-price contract.