Selecting the right pricing contract is one of the more important decisions you’ll make. The wrong decision can lead to a lot of headaches and lost revenue. So the decision between fixed fee and time & material pricing isn’t one to be made lightly.
The difference between the two methods is like placing bets on two horses at the Kentucky Derby. You’re risking a potential best return with either option. This article will aim to get you up to speed on both options so you can make the best choice for your business.
What are Fixed Fee and Time & Material pricing?
Before we dive in, let’s get clear on the terms we’re using. When we talk about ‘Time and Materials,’ this is where the client is billed for actual work completed.
And when we say ‘Fixed Fee,’ we mean that the client is billed for a fixed price set in the contract—no more, no less—regardless of the amount of time the project actually takes to complete.
Fixed fee arrangements often exclude material costs and expenses. That’s because the vendor doesn’t always control those items well enough to guarantee their price.
Additionally, there is typically some sort of overage protection put into place based on effort.
Who Takes the Risk?
The choice between fixed fee or Time and Materials pricing may seem insignificant, but there are important differences.
In a fixed fee contract, the vendor is typically taking all the project overage risk, while that risk falls to the client with time and materials contract.
With a Time and Materials contract, the client is betting that the project will take less time than estimated, and is willing to wager potential overages on that. Conversely, the vendor stands to make more money in T&M if the project goes over the estimated time, but will not make as much if they complete the project quicker than expected.
How Do You Choose?
Fixed fee arrangements incentivize the vendor to complete the work as quickly as possible, and for known client environments with low risk, this can be a much more straightforward way to do business.
But for projects with a lot of unknowns, T&M contracts can be the better option. One drawback is that they require a lot more tracking of time spent on delivering the project.
On the other hand, you’ll be able to ensure that you get paid for all of the resources you utilize on the project.
With a fixed fee contract, the incentive is on you to complete the work as quickly as possible so they can move on and realize a better gain on the project by beating the estimated time.
The potential drawback is that if you overlook something when developing the project, you may find that you either have to rush through the project or eat into your margin.
What’s Best for You?
In the end, you’ve got a decision to make. Both arrangements have their benefits, both have their risks. Which horse are you taking?