From the previous article, we know that hourly billing fails to reward innovation. We also know that the best solution for the client and vendor is an engagement based on value.
Of course, we all face a bias based on our own experience. If I am an accountant or lawyer who is used to billing by the hour, then I am often most comfortable engaging a vendor on an hourly basis. Consider this: If I help a company grow by $2 million a year, would they feel better if it took me 10 hours or 1000 hours to accomplish the task? Ironically, most of us are more valuable if we can deliver results quickly. Still, I often get asked “So, for that fee, how many hours will you spend?” It’s not their fault. It’s how it has always been done.
I remember purchasing IT support services. The vendor charged $1,500 per month with up to 8 hours of on-site support. However, the first few months our bill exceeded $7,000. I asked for an explanation. The service manager explained that in the 2nd month, they had to spend about 40 hours of labor to identify, diagnose, and repair a problem with a network switch. A replacement network switch would have cost about $1,500. More importantly, they were the ones who billed for 12 hours of labor the prior month installing that very switch. Ironically, the more mistakes they made, the more they billed… and expected to earn.
Several companies have shifted to a fixed-fee basis for IT services. As long as the client company’s IT infrastructure does not change, neither does their fee. These vendors recognize that their base fee may not always be the least expensive, but the client appreciates a predictable cost base. Most importantly, they share a common goal with the client: Namely, they have an interest in minimizing downtime, maximizing customer satisfaction, and bringing the right level of talent to solve the issue on the first visit.
You need to have well-defined requirements and mutual understanding on fixed-price projects. When faced with large, complex projects, realize that it is unlikely that you can predict the final deliverable. So, how can you propose a fixed-fee proposal without either assuming unreasonable risk or pricing yourself out of the market? Here are four steps for success:
- Understand the client’s Issue, Impact, and Importance of the project. Both parties will appreciate the value of the solution, and it will also help you avoid a non-decision as you reach the finish line for the contract;
- Break the project into steps. You can likely create a comfortable fixed-fee proposal for step 1… just not step 5;
- Provide an estimate by step. Step 1 might be a fixed fee. As you move further from today, the range might be wider. Step 2 might have a 15% variation from low to high, whereas Step 5 might have a 300% variation from low to high;
- Provide clear, tangible explanations of what could change the scope and costs: This is not the old days of low bidding and hitting the client with change-orders for every nitpicking variation. Rather, our goal is to build trust and confidence for this and future projects. Build in a buffer to account for typical deviations.
In my previous businesses, we preferred selling fixed-fee projects, and so did our clients. We typically delivered more to our clients than we originally promised. Since people were not concerned with billable hours, we were able to get to the root of issues faster, which resulted in quicker delivery times and higher margins for us. Everyone was happy.
Going from hourly billing to fixed fee does not have to be frightening. Start small, and be sure to over-communicate on the first project or two.
Next time, I’ll discuss the worst contract relationship you can have.