Custom Software Contract Conundrums: Why Time & Materials and Fixed Bid Don’t Work
Technology

Custom Software Contract Conundrums: Why Time & Materials and Fixed Bid Don't Work

February 21, 2018

How camping can be like a Time & Materials contractWhen EduSource founder Jason Beutler and I got married 18 years ago, it seemed like our family backgrounds were very similar. We both came from conservative parents, had two sisters, and had families that placed a huge importance on traveling together.

Imagine our surprise when we took our first vacations with each family.

Jason was shocked when a month prior to our first Lightfoot-family vacation, we received an email “Plan.” It included details such as restaurants we might want to stop at, routes we should take, and a day-by-day breakdown (with phone numbers and addresses) of exactly what the trip would entail. (Jason says that even bathroom breaks were scheduled in, but I think that’s an exaggeration.) Everything on the trip was booked as early as possible to get the best price available. The trip was planned out and set, so as long as we didn’t change our minds, things were on track to be good. Best price, but no flexibility. Think of this as a Fixed Bid vacation.

The Beutler side was the EXACT opposite. I was amazed when our final destination didn’t get booked until just a few days before we left. There was a lot of back and forth about where we should stay. We got the address to head to the day before we left. And after a few enjoyable days of camping in the woods, we had had enough and were hankering for the beach. So we packed up, threw our campsite food into a cooler, and headed to Lake Michigan for a few days. It was high tourism season, so the hotel prices were OUTRAGEOUS! We ended up with six of us staying in one hotel room with one bed. But we were at the beach! We ended up with wasted food from the abandoned camping trip and higher prices on everything, but we got to make up our minds as went. Think of this as a Time & Materials (T&M) vacation.

It’s THE question people ask when they start to consider having custom software developed: should I look for a T&M contract or a Fixed Bid contract? Why is this question so controversial? Because both contracts are far from perfect.

Shouldn’t there be a way to build software that encourages flexibility but also keeps the price under control?

As a matter of fact, there is another way. (There are actually several variations on these two standard methods. But we are really zeroing in on one.) But first, what exactly are Fixed Bid and T&M contracts? Here’s a breakdown:

Fixed Bid

What is it?

Fixed Bid is a contractual agreement to provide a specific set of software requirements for a fixed price.

English Please?

A software company agrees to create your custom software for a fixed price.

Why do people go for it?

Why clients love it:
  • Budget. They know from the beginning whether they can afford the software. It’s always easier to get budgetary approval for something that has a fixed price.
  • Less risk. They feel confident that the developers on their project will work efficiently. After all, if the project goes over budget, the software company will have to eat those costs. So the software company will be highly motivated to finish on time.

Why software companies love it:
  • Chance for high return. If they happen to finish the project early, they’ll get a great ROI. Of course, this rarely happens, so they aren’t holding out hope.

Sounds great. What’s the problem?

Software companies shy away from this method because the risk lies entirely with the software company. The company makes its best effort to bid out a specific project, but as we all know, clients will continue to get ideas throughout the project. (I’m tired of sleeping on the ground! I want to go to the BEACH!) This means that scope will constantly change, forcing the software company to basically hit a moving target.

Why clients don’t like it:
  • Losing flexibility. They risk not being able to change the requirements of the project on the fly. Something may not occur to the client until they’re well into development. They want to be able to implement those new ideas.
  • Higher price tag. Knowing that the software company has to make sure that the bid is high enough to cover unexpected complexity, the client has to expect the price tag to be higher. The software company has to cover that risk somehow, after all. It’s possible that things will be easier than expected, too, and the company may finish quicker than they expect. In that case, the client may not be sure that they got the value they wanted for the price.

Why the software company doesn’t like it:
  • Being the bad guy. No matter how much due diligence the software company does, the client will always have new ideas as they move through the process. When companies use a Fixed Bid method, they are forced to be the bad guy instead of a partner to the client. They have to be adamant about sticking to the original scope, even when it’s in the best interest of the client to modify things.
  • Or make the client mad. If they agree to make changes (called “change requests” in the software industry) that will take additional time, they have to risk frustrating the client by asking for additional cost to accommodate new scope. This seems sleazy, like nickel-and-dime-ing the client, especially since they originally signed a contract for a “Fixed Bid.”
  • Or else they just eat their profits. The software company doesn’t want to anger the client, and they also want to be a true partner to the client and make adjustments to original scope as needed. So they just end up losing money on the project. Obviously not a recipe for success.

We are used to getting a ‘Fixed Bid’ estimate in our daily life. If we take our car to the shop, we get a price for a certain set of work and we expect to pay that price. … It is very clear going in what the requirements are for the job and what the expected results are.  (Fixed Bid vs. Time and Materials – Pros and Cons)

Time & Materials (T&M)

What is it?

T&M is a contractual agreement where a client pays a specified hourly rate based on the number of hours developers or other employees spend on a project.

English Please?

The client pays per hour for the people working on the project.

Why do people go for it?

Why clients love it:
  • Peace of Mind. They know they’ll get the hours they pay for.
  • Flexibility. They can change requirements on the fly during development. If they have a great idea five weeks into the project, the software team won’t be trying to force them to stay with original scope.

Why software companies love it:
  • Low risk. If their client changes his/her mind during the course of the project or something ends up being more technically complex than expected, they know they’ll get paid for the hours they put into a project.
  • Partnership. They can help the client decide what’s right as they go along in the process. If the client makes a decision to pivot, it’s with the understanding that this will take extra time, which will raise the overall cost.

Sounds great. What’s the problem?

Clients sometimes shy away from this method, because it relies entirely on a strong trust foundation with the software company. Of course, mutual trust is the best-case scenario, but this almost never exists at the beginning of the first project. Clients don’t know how long it “should” take to complete software, so they aren’t sure if the developers are working as quickly and efficiently as they should be. The motivation to finish early is completely gone.

Why clients don’t like it:
  • No finish line. Though clients have ultimate flexibility, they might worry they will never get to the end of theproject. They may keep changing things or the software company may take longer than expected to finish the project.
  • No budget. It’s difficult to get approval for a project that doesn’t have a fixed budget. It’s possible that they’ll run through the allotted budget with only half of the project completed. THAT wouldn’t be good…

Why the software company doesn’t like it:
  • Nitpicking. The software company know they work best when they have an architect occasionally working with the developers. But the client just sees dollar signs on the bill.  The company wants to use the team that makes the most sense for getting the job done right, rather than worry that the client will be nitpicking about who touched the project and for how long.
  • Motivation. The software company actually makes more money if they take longer. They aren’t motivated to work smarter or faster because they’re getting paid hourly.

The number one benefit of developing with a time and material pricing strategy is the ability to postpone implementing some features that our client thought were inevitable. In more than a few cases, the initial RFP was very different from the final project. (Why Billing on a Time and Material Basis is a Guarantee of Flexibility)

So Why Don't Time & Materials or Fixed Bid Projects Work?

Think of it this way:

The client should be managing budget and scope. That’s what they are best equipped to manage.

The software company should be managing the project. That’s their expertise, and they know the best way to get the job done right.

In both of these models, the parties are motivated in the wrong way.

In T&M contracts, clients have to “manage” the projects, because their budget is on the line, and they have to be concerned with whether the team is working effectively and efficiently.

In Fixed Bid contracts, the software company has to manage scope and budget. They have to be the one deciding what does and doesn’t get completed in the project, because they’ve already determined how much time they can put into the project and still make a profit.

There’s got to be a better way – a way to incentivize clients through budget and scope and incentivize the software company through efficiency.

And there is.

Over 18 years of marriage, Jason and I have found what we think is the perfect balance of “planned ahead” and “flexibility” in our vacation style. And at EduSource, we’ve spent the past few months doing research, brainstorming, and working on our new pricing model, which will be a blend of T&M and Fixed Bid.

Watch for it in the next few weeks—we’ll make sure you know about it.

And in the meantime, if you’d like to get started with an (always free!) initial consultation about custom software, email info@edusource.us.

About Kendra

Kendra Beutler loves working with young adults. For many years of her career, that involved teaching at local universities. Now she gets to hang out with college students and young adults all the time at EduSource (the company’s average age is around 25, after all). Kendra is passionate about stories. She’s an avid reader of fiction. But she also loves a great in-depth feature story about anyone. When Kendra’s not working or carting kids all over, she enjoys making pasta sauce or specialty candies. And Kendra and Jason love to travel with their kids. Any reason is a great reason to throw everyone in the car and hit the road.

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