What Pricing Model is Right for Your Next Project?
Have you ever been part of a technology project that went over time or budget? I’ll bet most of you have and you have scars to prove it! The perceived solution to these painful experiences is often to request fixed bid pricing on the next project. But are fixed price contracts a panacea or just providing a false sense of confidence?
This article discusses the differences, negative aspects and benefits, of both fixed pricing and time and materials (T&M) engagements. The least appropriate scenario for a fixed price model is a complex technology project. Once I identify complex technology projects I’ll dig deeper into six reality checks you should be aware of for fixed price engagements.
Let’s begin by defining each pricing model.
Pricing Model Definitions
Time and Materials (T&M)
A T&M model is one where the vendor bills for their time and expenses. Time is typically recorded in hourly or a daily increments. Expenses include travel or acquiring specific materials/tools necessary for completing the work.
As its name implies, a fixed price is a specific price (it isn’t lower, and it isn’t higher) for specific deliverables. You typically pay based on verified milestones during the project.
The Pricing Model Dilemma
Fixed pricing and T&M pricing both have their place – and their risks. The general complaint of T&M pricing is that the vendor does not have the interest to control their work. The more hours that are put in, the more they are able to invoice (referred to often as an “open” checkbook”).
The downside of the fixed price model (which is many times overlooked) is the vendor has a built-in incentive to be as “efficient” as possible – but knowing where the vendor is “efficient” and where they are cutting corners, is very difficult for the average client to identify.
Fixed price quotes are specifically prone to error in complex technology projects. Here are five identifiers of a complex technology project.
1. High Visibility
Complex projects have multiple stakeholders with varying wants, needs and expectations. Organization-wide projects bring much greater visibility and a higher level of executive awareness. As a result, these projects require more cross-department collaboration and a higher level of communication and management.
2. Complex Technical Integrations
Few technical integrations are ever exactly alike. The reality is it is rare to find enterprise software that has not been customized. So while it may sound simple to say it’s just a “Salesforce” integration, the reality may be far more complex. Technical integrations often involve the need for cross-departmental alignment.
3. Multiple Vendors
Inherently, when multiple vendors are supplying different parts of a complex solution, the variables around interdependencies present an increased risk of delays and challenges.
4. Hard Deadlines
These are situations where there is a significant financial risk if the project is not completed at a certain date. For example, the expectation retiring legacy technical debt before a license renewal or ending the cost of a current platform as you go live on the new one.
5. A “We Need It Now!” Mentality
There are many time-sensitive, important initiatives which arise quickly and urgently. These create additional dangers if there isn’t time set aside to confirm assumptions, align stakeholders, and challenge the current state. A sense of urgency to start does not always allow thorough planning.
Fixed Price Reality Checks
Now that we have identified a complex technology project, I’ll share six reality checks to be aware of when considering a fixed price engagement.
Reality Check #1 – Information Disparity
In my involvement in hundreds of RFPs, I find two things in common: one, they rarely provide enough details of the current state; the challenges, bottlenecks, additional workarounds, and limitations imposed on them by current systems. The lack of more specific use cases creates vendor “guestimates” as there is not enough detail to envision the best solution and accurately estimate the true effort.
Second, the future state expectations and requirements may be too aspirational without enough specificity – again restricting the ability to tailor a complete solution. The vendor knows issues exist and knows there are specific reasons for asking for specific capabilities, they just are not fully explained or disclosed. Together these two situations create a disparity of information between the real-life issues occurring in organizations and the lack of clarity on our part to allow the creation of optimum solutions at an accurate price.
This failure to do a rigorous analysis around the current and desired state, and ensuring all levels of stakeholders have an accurate and aligned view, is the number one factor that causes projects to go over budget. Asking for a fixed price during the proposal or RFP stage generally results in incredibly inaccurate commitments.
Reality Check #2 – Fixed prices Equals Fixed Scope
Yes, there is a fixed price, and it comes with a fixed scope too! While this may seem obvious, the reality is few scope documents can be accurately written at the beginning of a project. It’s also rare for a contract or Statement of Work (SOW) to be detailed about features and functionality so early on. You then find yourself without the capabilities you envisioned. Ambiguity is not your friend in a fixed price contract.
There are times when scopes are written in great detail still cannot describe exactly what you desired or intended. There will be times that you won’t know what you want until you see it, and in a “Fixed Price – Fixed Scope” contract, that is too late. At this point, you are reviewing deliverables according to the contract, rather than your expectations. There may be an option to change your mind (and change the price and scope) but the work that has been done up to this point will need to be honored in payment.
Reality Check #3 – Change Orders
When the length of a project is over 6 months there is a high possibility that new information or requirements will arise. Guess what happens? Change Order Hell. Anything that strays from the scope and its assumptions and exclusions becomes a change order, and with change orders, there may be pricing fluctuations…and additional scrutiny. Nobody likes them. The vendor does not like to have to stop progress, write up the change, present a case for the change, and perhaps argue for the change. On the other hand, the customer does not want to see the cost of the project increase from the initial budget.
Reality Check #4 – Sitting at the Chef’s Table (Fixed Price = Limited Transparency)
You may not care about transparency. Your focus is simple and straightforward: a quality product, delivered on time and at the fixed price. This situation is comparable to a normal dining experience versus dining at a chef table. In the dining area, you choose a menu item and it is prepared and brought out to you. When dining in a restaurant that offers a chef table, you are seated in the kitchen, discuss menu options with the chef, place your order, and observe the chef prepare your meal. You not only see the ingredients, but you also see the amounts of each ingredient and the order in which they are added during preparation. While you watch, you might ask for a little more garlic or another custom ingredient specific to your taste.
Fixed price agreements are akin to ordering in the restaurant’s dining room, where T&M is more like the chef table experience. In fixed price agreements, milestone billing is traditional.
Consider a fixed price agreement to which you agreed to a $100,000 price. At the conclusion of the project, it may come in higher (at the vendor’s expense). Or it may have come in under, at your own expense. In either case, an agreement was met and hopefully, you are satisfied in either case.
What you miss in fixed price and milestone billing engagements, however, is the knowledge of how the product/project was built on a detailed basis. You may never know the real effort and the variables that were involved. T&M projects provide deeper project insight, allowing you to learn more and using this in-depth knowledge in future projects.
Reality Check #5 – Some Vendors Love Fixed Price RFP Requests
At this point, you might ask yourself “Why would a vendor accept a fixed price contract?” The answer is threefold:
- They see the lack of detail in the scope and the openness for interpretation, and contrary to your interest, they see the ambiguity in scope as an advantage to them.
- They may just need the business, regardless of the risk.
- They know with a fixed price there will be change orders, and that is where they will make up their margin.
We define an RFP with the following characteristics as a “loose” RFP:
- Lack of deep current state analysis.
- Desired state that primarily addresses high-level goals.
- Broad, contradictory, or ambiguous terms.
- Ability to define terms, definitions, and meaning to the vendor’s advantage (in order to limit the scope and/or price).
These RFP’s are highly susceptible to conflicting interpretations and going over-time or over-budget. I would submit, that under the definitions of a complex project and a “loose” RFP, if a vendor is not pushing back on providing a fixed price during RFP it should be a red flag!
Reality Check #6 – Contract Termination
In most T&M contracts your termination clauses will allow you to stop a project with some advance notice and only pay for the vendor’s time expended up to that point. Conversely, under a fixed price agreement, your termination may be less flexible and exactly what you owe may be less apparent, resulting in a more complicated termination.
For example, you might feel you are only 25% of the way through a project timeline, but the vendor has worked ahead with over 50% of the fixed price being invested. Termination of fixed price agreements may result in unintended consequences.
Begin with a standalone discovery effort with the selected vendor. Even if you have performed a thorough discovery internally, it is going to look different in the eyes of the vendor. It is far better to get confirmation early in the effort, and in the best-case scenario, they will confirm your expectations. Worst case? You’ve learned more during the discovery engagement, and you have no further contractual responsibilities. You can then reset expectations, budget, scope, and timelines.
We have found the most satisfying and successful approach is following an Agile Scrum framework, where there is deep collaboration throughout the project. This iterative methodology allows for weekly feedback, course correction, and validation throughout the design and development stages. It delivers “Quick Wins” around functional products using Agile’s MVP (Minimum Viable Product) and MMP (Minimum Marketable Product) approach. Our clients have found this process to deliver project transparency, and better solutions quicker and at a lower risk, than the traditional fixed price, waterfall projects.
There are a time and place for both fixed pricing and time & materials engagements. Don’t write off a T&M model without considering that a vendor with a fixed price might take advantage of your organization by doing the least possible work to fulfill a scope. Fixed price contracts are not a panacea, and can result in greater risk, price, and administration.
Each model has explicit advantages and disadvantages, which allows you to make an objective decision about what is best in your specific project. Resist the perceived safety of a fixed price. There are many benefits to the T&M model, not the least of which is getting exactly what you want and knowing exactly what you paid. Hopefully, this article provided a deeper understanding of the underlying variables in both pricing models.