The financial risks of customer and contractor

How is is the risk profile of building a runway different from developing a smartphone? For a contractor providing services the risk and reward profile is completely different than for the developer of a product.

The airport will be responsible for that runway long after construction is finished. For them, that runway is a product, even though, unlike a smartphone, it will not have to be reinvented next year. It may need maintenance, but that is a small effort compared to the updated smartphone.

When developing a product, you are investing today in the hope of a return tomorrow. At the beginning you lose money, but you expect to get a return on your investment. This can be the more profitable approach because your revenue is not directly tied to the cost of production, but you have to finance the investment and might lose the up-front costs if you are not successful.

Hypothetical Cash Flow of a Successful Product Development Project

Your fundamental risk is that you won’t get the return you had hoped for. This might be caused by “delivery risk” – your supplier doesn’t deliver something you can use – or by “market risk”– you build it, but no-one wants to use it or buy it.

Scrum is quite suited to Product Development, because a constraint on a Scrum Team must create something which can be shipped at least once per month. So, your delivery risk is effectively zero (assuming your team is really following Scrum). If you work effectively with customers and stakeholders, you can also reduce your market risk.

If you are the supplier, you are doing work for someone else. Usually, you are getting paid for the work. Your costs and revenue are directly tied to each other. Your margins are lower, and your risk profile is different. In particular, a supplier usually does not take on the market risk of the product. So, whether any airlines choose to land an A380 on that runway is not the construction company’s problem; that risk is taken by the airport operator.

	Hypothetical Cash Flow of a Successful Services Relationship	with a constant team size