A Solution to Fixed-Bid vs. Hourly Contracts (Part 2)

A few weeks ago, I wrote about how hard it is to estimate creative projects including sophisticated software development like we work on here at Six Feet Up.

From that post:

"When every project has unique requirements, how can a precise estimate be developed? (It can't.) And how can any project move forward without a reliable budget estimate? (Again, it can't.)"

Given that a budget gets set based on a guesstimate that’s more likely to be wrong than right, what’s the best way to set up a contract?

What Makes a Good Contract?

A contract defines a structure for managing your project. A good structure provides:

• Confidence: Set and manage your budget
• Transparency: Know how much money you’ve spent at all times
• Visibility: Know how much of the project is done, and how much is left to complete
• Understanding: Understand the impact of any desired scope changes (and allow you to make them in the first place)
• Alignment: Make sure your service provider is properly incented

Fixed-Price Contracts

While fixed price projects seem to provide you with confidence, reduced risk, and incentives for us service providers to get the work done faster, they just don’t get you the items above.

Our strategy and design partner Abstract Edge did a great job explaining why fixed-price contracts aren’t as wonderful as they seem.

The key takeaways are that fixed-price projects set the wrong incentives, tend to be overpriced, and are inefficient, unending and inflexible.

Hourly, But With a Cap

A better way to handle this might be to pay by the hour, but with a cap. This gives you more flexibility, but some protection if things get out of hand.

But there are hidden problems. First of all, the service provider is penalized for finishing the work ahead the schedule, which is the wrong financial incentive.

Second, if the project hits the cap, it becomes a fixed price project anyway, with all of the issues I described earlier.

Time and Materials

The traditional way to pay for professional services is “time and materials.” This simply means that you pay based on the amount of time it takes to complete the work, plus for the cost of any out-of-pocket items. We’re all used to paying contractors and lawyers this way.

The time increment can be hourly, daily, weekly, or even monthly. For companies like Six Feet Up, hourly works best because it creates more flexibility for our clients than larger time increments.

On the other hand, what if we completely underestimated the project scope? Isn’t it too risky to pay by the hour?

Not necessarily. It’s how nearly all of our clients do it, and we have a lot of happy clients.

The key to reducing the risk of time and materials is transparency and frequent check-ins.

Reducing Risk

A successful engagement must transparently manage your risk, enabling you to see exactly how your dollars are being spent, and empowering you to make frequent, well-informed decisions that concern the budget and scope.

Time and materials is the only billing method that can support confidence, transparency, visibility, understanding, and alignment, but only with strong and effective project management processes in place.

Our proven project management methodology, which we call “Flex 6,” is the key to a successful project outcome. Flex 6 aligns interests and minimizes risk. It provides transparency and allows flexibility. It’s relationship-building and hands-on.

How does it work?

Don’t miss part 3 where I describe how we manage risks inherent to software development….

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