One of the things a lot of businesses struggle with is creating pricing that is both fair and attractive. This is particularly difficult when a business sells services – those intangible things.
There are three main pricing models: Fixed-Fee Contracts, Time and Materials, and Time and Materials, Not to Exceed. Today I’ll talk about some of the pros and cons of each of these models.
Fixed-Fee Contracts
A Fixed-Fee Contract is best when both parties agree on the results or outcomes. A fixed-fee project encourages and rewards innovation and timeliness on the part of the vendor. If they complete the project more quickly than expected they still get the full amount of money, while the client receives a faster than expected turnaround. Everyone wins!
One downside of fixed-fee pricing comes when you think of a time frame, task, or client in isolation. Doing so often leads to over-pricing to lower your risk, causing the price to become unreasonable.
This can be avoided by following these rules:
- Remember that your goal is to provide good value over time. If you find that, on average, both you and the client are happy with your arrangement then don’t get too focused on the times when you might be over or under your typical price point.
- Document and agree on things that aren’t included in your fixed-fee pricing. If one of these circumstances comes up, be clear that it could change the project scope and the price.
- Clearly define your timeframe and what success looks like. If your client ends up wanting to change the timeframe or scope they can pay more for these changes.
- Be sure your termination agreement is clear. It is best to set this at one month’s notice so that if things aren’t working out you don’t feel stuck and can move on quickly.
Time and Materials
A Time and Materials Contract is best when there is uncertainty about the scope of the project or desired outcome can’t be easily defined. These kinds of projects carry a risk to both parties because the client is paying based on effort instead of results.
Whenever possible it is best to try to move to a Fixed-Fee Contract, but if that’s not possible make sure that the terms are clear to both parties before deciding on this model.
Time and Materials Not to Exceed (T&M NTE)
Often in contracting, I see vendors propose this kind of contract. T&M NTE means that you bill based on effort, but only up to a certain point. Once you hit that limit, you are no longer entitled to bill for additional time. This is different than a fixed-price model.
While a Fixed-Fee Contract rewards you for efficiency, with a T&M NTE allows you to bill for time up to the limit. So, if you work efficiently, then you only get to bill for the hours expended. However, there is a penalty if you go beyond the planned maximum effort. If you underestimate the effort required for the task or if the scope of the project changes but doesn’t warrant an actual change of scope with the client, then every hour you go over begins to erode your profit. Because there is only a downside you should never agree to this model as a vendor. Proposing T&M NTE is a dangerous trap that pushes you into the vortex of evil.
As a client, you also should avoid T&M NTE. Many companies assume that the vendor should know what their maximum effort should be and that if they exceed it they can’t charge anymore. However, if the vendor ends up being upside down in a project usually it will affect the project in at least one of the following ways:
- They will only deliver the minimum amount possible.
- They will stop using high-value resources and try to only use low-value ones.
- They will make up the difference by underperforming on other projects.
If you are offered a T&M NTE that you think has a reasonable maximum value then ask for a Fixed-Price model instead. This way, your vendor at least has the opportunity to benefit from their efficiency.
Sell Results Not Resources
Ultimately, the key is to focus on results with your client or prospect. Your client likely doesn’t care about your effort. Rather, they often are evaluating whether the investment is worth the potential result you can deliver. The closer you can get to fixed-fee pricing, the better you can shift the focus to results and avoid the commodity trap.
Share Your Story
How have you struggled with pricing? What models have you found to best for you and your business?
