What’s Easier to Manage – Fixed Price or T&M?
As a project manager you will, at some point in your career, manage a project with each of these types of budget constraints. Sometimes organizations will exclusively work on either a Fixed Price or Time and Materials (T&M) basis, other organizations will structure their contracts to suit the customer or prospects needs. Either way, each pricing model presents advantages and challenges that I’ll touch on in this post.
This is clearly the biggest distinction between the two pricing models. Either can be favorable to the selling org or the customer depending on several factors such as clarity of requirements and accuracy of estimates. T&M is a very simple model – every hour worked represents an hour to be billed to the customer (extenuating circumstances notwithstanding). Scope management becomes less of an issue (I said “less” not “non-existing”) so long as the project manager and the customer are aligned with work being performed. In well estimated and well managed projects this can often lead to a reduction in the overall price tag to the customer.
Fixed price can often times be less of a headache to manage when it comes to budget simply because there’s really no discussions (provided the scope stays intact – see below) around how to handle budget overages – it’s all on the selling org to take care of those. Counter to that, if the work gets done with less effort than originally estimated then that gives the selling org a higher profit margin. Customers will often prefer fixed price so that they have that cost certainty. But with that certainty comes a reliance on the wording of the scope in the contract, which brings me to my next point.
On Fixed Price projects this is critical. Without proper scope management, fixed price projects can quickly spiral out of control and lead to some very challenging situations. When embarking on a fixed price project, scope clarity is essential to getting off on the right foot. Understanding and getting consensus from the customer on what is to be delivered (and how) is vital to properly maintaining your fixed price budget. Keeping new scope outside the boundaries of your project is essential. This all starts with a well-worded contract with no uncertainty around what is to be delivered. Constant vigilance during the entire project is also crucial. Communicating with your client to constantly ensure alignment is a great way to keep both parties on the same page with respect to the scope being delivered. And if there are misalignments, get in front of them early and address them with your customer (in writing!) to ensure that everyone is working in concert together.
You might be asking yourself what is different when it comes to status reporting between fixed price and T&M projects. Well the main difference is when it comes to reporting on budget. Fixed price engagements don’t necessarily need to report hours burned, remaining budget, etc. Internally this information is vital to ensuring your profit margin stays healthy but as far as customer reporting goes, it’s not typically something they would expect from a fixed price engagement. Not to mention if your burned hours are way below what you expect (thereby increasing your profit margin) you may not want to broadcast that out to your customer. Now for T&M projects, every hour counts and it should be one of the most visible pieces of the status report – your budget, actuals-to-date, EAC (Estimate at Completion) and ETC (Estimate to Complete) are four key pieces of information that most customers will seek out for a T&M project budget status report.
People often ask me what my preference is when it comes to managing different pricing models of projects. I usually reply that it is less of a factor depending on the nature of the customer and the type of work being done. The higher the certainty of everything usually means that Fixed Price is an optimal model. If there is higher level of ambiguity or if the trust is not quite there between the customer and your organization then T&M may be a safer model to go with in terms of pricing out your engagement.