Pricing - fixed price + T&M hybrid
Welcome to the third article in my pricing series, after Fixed Price and Time and Materials.
So I found fixed price to be too ridged, and often the negatives outweighed the positives. Whereas time and materials didn’t fly with larger government and corporate projects, where one single price is nearly always required.
In the third iteration of pricing methods, I combine the two - a hybrid between fixed price and time and materials.
Now it’s not revolutionary, but I found by setting the pricing this way, and introducing a few project management techniques, clients could still integrate feedback and the project evolved.
Best of all managers (or those controlling the cash) are happy because it seems “fixed price” - so it’s a win win.
Fixed price for initial scope (with contingencies)
“History is about great forces, yes, but also about contingency” – Margaret MacMillan, Historian
We all know the benefits of charging a fixed price. You can charge what you want in order to win the work, and you’re guaranteed that amount (unless you royally screw it up). One clear figure is easier sell to a client, especially if you’re bidding for a tender.
So with this hybrid pricing method, you still do it all the same. Run an in-depth scoping phase (ideally a Project Workshop), do your thorough estimation as usual, and price it so you feel confident with the figure.
The difference to classic fixed price, is that two additional contingencies are added to the estimate:
1. Technical risk contingency
This is a percentage you add to the estimate to handle unforeseen technical issues. The amount depends on the “riskiness” of the project, e.g. how many external libraries or vendors you need to be dealing with. But on average, I would say somewhere between 10% and 20%.
There is no need to include this as a line item in your estimate if you don’t want, you can instead build this into the individual development estimates. This is your own internal contingency - so the client doesn’t necessarily need to know the specifics (but if you want to let them know that’s fine).
You use this technical risk contingency when you need.
It’s a buffer, so you don’t need to track the time. If it turns out you don’t need it - great. That's a bonus of fixed price.
2. Project enhancement contingency
This is a percentage you add to the estimate to handle “project enhancements” - which is a polite way of avoiding using the term “scope creep” with your client.
Clients will be clients, and the scope will creep.
An amazing feedback item can send a feature in a different direction, which isn’t a bad thing. If it makes the project better, it should be embraced. The percentage here is very dependent on the client and the project, but again I would say around 10% to 20%.
Unlike the technical risk contingency, you should clearly let the client know how much “project enhancement” time you have allotted in your fixed price. It's important they are aware of this.
You should also let them know in your proposal how this time works. A fixed number of hours that they can use to add, remove, and improve items that were not in the original scope.
The important part is that these hours are tracked, and they cannot go over this without increasing their budget.
For the project enhancements, I found it easier to save all of these to the end, instead of working on them during the sprints to deliver the initial scope.
This way all client feedback that is agreed to be out of scope is simply put in the backlog, and completed after the initial scope of work is finished.
Time and Materials for additional
“The only reason for time is so that everything doesn't happen at once” – Albert Einstein
Everything that is not in the original scope, and doesn’t fit into the project enhancement contingency time allotted - is then charged on a time and materials basis.
For example, say in a 3 month project you allotted 15% enhancement contingency, equating to 13.5 days. And upon completing the initially agreed scope there were 22 days worth of enhancements in the backlog.
You client would then either
- Choose 13.5 days worth of features from the backlog to stay within their fixed price
- Pay an additional 8.5 days (at time and materials) to implement all the features
This is a simple concept, and if you clearly explain up front that this is how you work, then everyone is on the same page from the start.
Relationships suffer when things change unexpectedly, so it’s about setting expectations.
I’ve found that when clients know they have a contingency baked in, they are more open to suggestions and ideas which is a good thing. It’s their product - they should be!
Ultimately it means more items are added into the backlog, they are more proactive with new ideas, and this usually means more ongoing work past the initial scope.
Allow exchanging features
“Computers were programmed to swap out error-prone, inconsistent human calculation with digital perfection” – David Autor, Economist
The reason I like the hybrid approach is that it brings more flexibility into a fixed price arrangement. And something else that can expand on this, is allowing the client to swap features of a similar size.
For example - If halfway through they have this great idea for "Feature X" but it is too big to fit into the enhancement contingency, they could choose to remove previously scoped "Feature C" and "Feature D" - in order to fit in the new feature.
If managed incorrectly this could get a bit messy, as your client might end up swapping everything at the last minute. But as long as you set some clear boundaries, this is a great option to reduce some of the rigidity of a fixed price project.
Some tips if you decide to include this
- There needs to be a discussion and research done. Not all features can be removed, especially if ground work has been laid
- The client needs to formally request the change at least a week or so before the sprint starts
- I suggest adding additional time to the new item to cover the change overhead (project management, research etc). This can come out of the enhancement contingency.
After trialing the hybrid pricing method a few times with good success - it became our go to for all projects requiring a fixed price.
I found it reduced a lot of the negatives of both fixed price and time and materials, and more arguably more importantly, encourages a fruitful ongoing client relationship.