Differences and Pros and Cons between Prime Contractors and Subcontractors in System Development

In the course of conducting business, many of you may have come across the terms “prime contractor” and “subcontractor”. However, because these terms are so commonly used, there may be some who feel they have a vague understanding of what “prime contractor” and “subcontractor” mean, and what the differences between the two are. As these concepts are frequently encountered in business, a lack of solid understanding could potentially lead to unexpected disputes. Therefore, in this article, we will explain what “prime contractor” and “subcontractor” mean in the context of system development, what the advantages and disadvantages of each are, and what the differences between the two are.

https://monolith.law/corporate/system-development-difference-subcontract-decision[ja]

About the Prime Contractor

First, let’s explain what a prime contractor is and what the advantages and disadvantages are.

What is a Prime Contractor?

A prime contractor is a contractor who directly undertakes work from a client. The term “prime contractor” refers to a business or individual who acts as a prime contractor. In the context of system development, a prime contractor is a business or individual who directly undertakes system development from the client (the party commissioning the development).

Advantages of Being a Prime Contractor

So, what are the advantages of being a prime contractor? Let’s explain them below.

Freedom to Determine the Amount Presented to the Client

One of the advantages of being a prime contractor is the freedom to determine the amount presented to the client. As a prime contractor, you will be directly contracting with the client, so you can freely determine the content of the contract. As a prime contractor, you can present an amount to the client that suits your own wishes, considering the relationship with costs and profits.

Easier to Generate Profits

Another advantage of being a prime contractor is that it is easier to generate profits. The main ways for a prime contractor to increase profits are to increase the amount presented to the client and to reduce costs. If a prime contractor uses a subcontractor, they can increase their profits by reducing the costs associated with the subcontractor. However, as we will explain in detail below, care must be taken not to violate the Japanese Subcontractors Payment Delay Prevention Act (Subcontract Act).

Broad Range of Work That Can Be Accepted

Even if the scale of the work is too large to be handled by the prime contractor alone, there is a possibility that it can be accepted if there are subcontractors. For example, even in the development of a system that is technically difficult for the prime contractor alone, there may be cases where technically difficult issues can be overcome by cooperating with subcontractors. In this way, the range of work that can be accepted becomes wider by cooperating with subcontractors, which is also an advantage of being a prime contractor.

Disadvantages of Being a Prime Contractor

One of the disadvantages of being a prime contractor is the potential for an expanded range of responsibilities. When a prime contractor works with a subcontractor, there may be cases where the client suffers damage due to a mistake by the subcontractor. In such cases, the prime contractor cannot argue that they are not responsible because it was the subcontractor’s mistake, and it is usual for the prime contractor to also bear responsibility. This potential for an expanded range of responsibilities is a disadvantage of being a prime contractor. Therefore, as a prime contractor, it is necessary to carefully select subcontractors and find reliable ones.

https://monolith.law/corporate/the-law-of-project-involving-subcontractor-fails[ja]

About Subcontracting

Next, we will explain what subcontracting is and what its advantages and disadvantages are.

What is Subcontracting?

Subcontracting refers to a situation where a prime contractor or a prime contractor person entrusts all or part of the work they have undertaken from a client to another contractor or person. The contractor or person who undertakes subcontracting is often referred to as a “subcontractor”. Considering the case of system development, the prime contractor or prime contractor person undertakes the development of the system from the client (contractor), and the subcontractor or subcontractor person undertakes the development of the system that the prime contractor or prime contractor person has undertaken.

Advantages of Subcontracting

One of the advantages of subcontracting is that subcontractors receive work from the prime contractor, so if the relationship with the prime contractor is good, they can continuously receive work without needing to conduct sales activities to acquire new customers. For example, if a subcontractor has technical skills but weak sales skills, they can receive stable work by partnering with a prime contractor with strong sales skills. For instance, in the case of system development, if the system development company, which is the prime contractor, receives work, the structure is such that work also comes to engineers, etc., who are subcontractors.

Disadvantages of Subcontracting

On the other hand, one of the disadvantages of subcontracting is that because they receive work from the prime contractor, their position is inevitably weaker than the prime contractor, and they may be offered a low amount for the contract fee, or be forced to negotiate a discount. As a prime contractor, it is common to have multiple subcontractors perform the work, not just one subcontractor.

For example, when a system development company receives work from a client, it often requests estimates for contract fees, etc., from multiple subcontractors and has the subcontractor who will do the work at the lowest cost do the work. For work requested by a client, unless it is work that requires high technical skills, if it is work that can be done by a subcontractor with general technical skills, they simply request the subcontractor who will do the work at the lowest cost among multiple subcontractors.

In this way, since the prime contractor often requests the subcontractor who will do the work at the lowest cost, the subcontractor may be forced to do the work at a low contract fee, etc., in order to get a job request from the prime contractor, or may be forced to respond to a discount negotiation from the prime contractor.

Regulations under the Act on Prevention of Delay in Payment of Subcontract Proceeds, Etc. to Subcontractors (Subcontract Act)

Under the Subcontract Act, parent businesses are prohibited from 11 items. Even if the consent of the subcontractor is obtained, or even if the parent business is not aware of the illegality, it will be a violation of the Subcontract Act, so careful attention is required. In particular, attention is required for the provision prohibiting “knocking down” (Article 4, Paragraph 1, Item 5 of the Subcontract Act).

When a parent business determines the amount of subcontract proceeds at the time of ordering, it is a violation of the Subcontract Act as “knocking down” to unfairly set a significantly lower amount compared to the consideration usually paid for the content of the same kind or similar benefits (or provision of services).

In other words, it is illegal for the prime contractor to make demands, etc., that conflict with the Subcontract Act against the subcontractor. For details on the Subcontract Act, please read the following article.

https://monolith.law/corporate/outline-ofthe-subcontract-act[ja]

Difference between Prime Contractors and Subcontractors

We have been discussing the concepts of prime contractors and subcontractors. The major difference between the two lies in who is commissioning the work. Depending on who the client is, different advantages and disadvantages may arise.

Summary

We have explained the differences, advantages, and disadvantages between the main contractor and subcontractor in system development. The terms “main contractor” and “subcontractor” are frequently heard in business and are important concepts, but surprisingly, many people do not fully understand them.
To avoid regret later, let’s make sure to understand the concepts of “main contractor” and “subcontractor”. If you have any concerns about understanding these terms, please consult with a legal expert or attorney.