Fixed Price or Time & Materials
There are different ways to quote customers for work to be done. If customer wants you to produce X, you need to determine a price for the work and the material needed to provide that. There is fixed price quotes and various forms of time and materials quotes. Time and materials means that you set a value for your time, estimate the amount of time, and estimate that cost. Fixed price means that you will charge a certain amount regardless of the effort needed to produce the work.
Just so we’re certainly speaking the same language:
- Cost – the amount of money you will pay to perform the work for the customer
- Price – the amount of money the customer will pay you
- Rate – the price you charge for labor
- Effort – the number of hours estimated to do the work
In a Time & Materials project, you have the rates and the effort, so you can provide a T&M Estimate to your client. If the estimates are too high, the customer will be billed less than the estimate. If the estimates are too low, the customer will have to decide to go with what was produced under the original budget or they will have to find more money to cover the cost. The customer owns the risk for the project, and they have to decide for themselves if the estimate is appropriate based on your references or past performance.
In a Fixed Price project, you have the rates and effort, and you own the risk if the estimates are too low. This means, if the project goes over budget, you’ve committed to a fixed price and you need to deliver for the agreed price. You own the risk. You have the benefit of larger profit if the effort is less than expected. You have the consequence of losing money if the effort is more than expected.
Anyone in contracts will advise to avoid “Time & Materials to a Limit” pricing. This means that it is less than that amount if the effort is less, and the cost is limited to the limit if the project goes over. You own the risk of the project if the effort is more than expected, and you do not have the benefit if the effort is less than expected. This is theoretically the worst type of contract for a vendor of services.
Here’s an example scenario. Here’s what you know:
- You have a project to be done, and you are estimating the project to be done for your client
- The requirements are totally understood, and the you and your client know what the end goal is
- You have the team ready to go
- You know the billing rate for each member on your team
- You have estimates for the work effort to be done and everyone is confident in those estimates
- You and your client will be working together in the future so the relationship at the end of this project is important
Here are four examples of these projects:
| Fixed Price | Time & Materials | Time & Materials to a Limit | Time & Materials with Risk Applied |
| 1. T&M rate will be $100,000. 2. Risk is determined to be 20% of the cost 3. Client is offered a $120,000 fixed price contract. | 1. T&M rate will be $100,000. 2. The client is proposed with a $100,000 T&M price contract. | 1. T&M rate will be $100,000. 2. The client is proposed with a $100,000 T&M price contract. | 1. T&M rate will be $100,000. 2. Risk is determined to be 20%. 3. The client is proposed with a $120,000 T&M price contract. |
| Risk: You own the risk, and the project costs you more if the effort was underestimated. | Risk: The client owns the risk, and the project costs the client more if the effort was underestimated. | Risk: You own the risk, and the project costs you more if the effort was underestimated. | Risk: You own the risk, and the project costs you more if the effort was underestimated. |
| Opportunity: You get paid more if the job is less effort than expected. | Opportunity: The client pays less as less work needs to be done if the project was over-estimated. | Opportunity: The client pays less as less work needs to be done if the project was over-estimated. | Opportunity: The client pays less as less work needs to be done if the project was over-estimated. |
Let’s say the project was easier than estimated. Here’s what happens:
| Fixed Price | Time & Materials | Time & Materials to a Limit | Time & Materials with Risk Added |
| You make more money because the client committed to a fixed price. The client is happy to receive their product, and you are happy to deliver profitably. | You make less money than under fixed price, but your time is covered. The client is happy to receive their product as expected for less than the amount discussed. Maybe the remaining budget could be used for improvements and other activities. | You make less money than under fixed price, but your time is covered. The client is happy to receive their product as expected for less than the amount discussed. Maybe the remaining budget could be used for improvements and other activities. | You make less money than under fixed price, but your time is covered. The client is happy to receive their product as expected for MUCH less than the amount discussed. Maybe the LARGER remaining budget could be used for improvements and other activities. Note, you have a choice here - you would have given this price if it was a Fixed Price estimate. You may decide to provide some of these changes for free. |
Let’s say the project was more difficult than estimated. Your timeline will need to be extended. Here’s what happens:
| Fixed Price | Time & Materials | Time & Materials to a Limit | Time & Materials with Risk added |
| You will either not make as much profit or perhaps even lose money on this. The client is annoyed the project will take longer. You become more sensitive to minor changes requested by the client. You will factor this loss into future projects with the client. | The project has run out of money. The client has to go get more money to accomplish the scope initially requested. Your costs are consistently profitable. The client does not trust your estimates in the future. | You will either not make as much profit or perhaps even lose money on this. The client is annoyed the project will take longer. You become more sensitive to minor changes requested by the client. You will factor this loss into future projects with the client. | The project has run out of money but not as bad as T&M without the added risk. The client has to go get more money to accomplish the scope initially requested. Your costs are consistently profitable. The client does not trust your estimates in the future, but you weren't that wrong. |
Let’s say the project was on time, but the client is asking for more and more changes. This is addressed with agile development embracing change and improving the final outcome for the client.
| Fixed Price | Time & Materials | Time & Materials to a Limit | Time & Materials with Risk added |
| Every change costs money and no one wants to pay it. You have a hard conversation. Paperwork needs to be prepared and approved. | Change is easy. If the client wants more then they will just pay more. They'll need to monitor the budget, but the total effort is proportional to the final price. | Same as Fixed Price. Every change costs money and no one wants to pay it. You have a hard conversation. Paperwork needs to be prepared and approved. | Change is easy and even easier because you added the risk padding. If the client wants more then they will just pay more. They'll need to monitor the budget, but the total effort is proportional to the final price. |
I was asked about car repairs in this regard. They have a bad reputation for estimating either too high for Fixed Price or taking longer than necessary for Time & Materials. You don’t have to build a relationship, and the customer can easily just not go back for future work. Ideally, you want to build trust for long term relationships and positive references for future work.
Apply this effectively
Coming in under budget is positive for your client, it establishes trust and faith in your estimation / delivery, and offers both parties options for what to do with the remaining budget. IT projects will always have change, and fighting about payment for every change leads to battles and distrust. As a comparison, fairs will always suggest a lineup will take longer than it really does, and it’s obvious that if you get out of line (introducing change yourself), you’ll have to wait longer when you get back into line. There’s a bit of frustration up front, and then happiness at the end.