Prepared by Percy Chinoy
Director Customer and Business Development
Some time back we needed some new electrical outlets installed in our house. It was a straightforward well-defined job and we got fixed-price (FP) quotes from two electricians and picked the one who gave us the lower price and could complete the job within a week. The electrician delivered as promised and left behind a satisfied customer. On another occasion, we had a water leak whose source was uncertain and would require peeling back the dry wall to determine the root cause. We called a couple of general contractors, one of whom gave us a rough estimate but would only do the project on a time and materials (T&M) basis due to the inherent uncertainty in the scope. The second one gave us a Fixed Price quote but with the caveat that we could get change orders depending on what he encountered behind the wall. We ended up going with the T&M contractor and he apprised us regularly of the status and how much he had expended. We made joint decisions on the major tasks and expenses and he ended up finding and fixing the leak within the original estimate.
Two different pricing models for providing a service and each one ended with a satisfied customer. Both models involved an element of trust in the service provider although the bar was certainly higher in the T&M case. As a customer, I felt more in control of the T&M project which mitigated any discomfort from the perceived “open-ended” nature of the T&M model. On the other hand, any delusion of certainty of the FP model was shattered by the prospect of change orders depending on what’s behind the wall.
DCI has a long history of successful projects with the T&M pricing model. At DCI, we help our clients take a Proof of Concept (POC) design through a systematic phased development process into a manufacturable and cost-effective design and prototype that can be transferred to volume production. When clients approach us with their POC, the degree of completeness varies from a bench-top unit held together with paper clips and duct tape, all the way to a scaled working unit with industrial design. Similarly, the documentation varies from rough sketches and brief description, all the way to a detailed specification, solid models and Bill of Materials of the POC.
Regardless of the degree of completeness and refinement of the POC, DCI follows a systematic estimation process with the customer that starts with a bottom-up list of tasks in a Work Breakdown Structure (WBS), then estimating the time to complete each task and then translating it into the estimated project schedule and budget. DCI iterates the estimate with the client at each step to get their buy-in so there are no surprises at the end. Moreover, DCI operates open book so the client has full visibility into the financials during project execution.
Even with such a systematic and detailed estimation process, the nature of development inevitably leads to changes along the way. Often it is a series of innocuous requests from the client such as “what if we changed this one more variable” or “could you please take a look at this” which could add significant amount of effort to the scope. Such questions are perfectly legitimate and even necessary in a development project but are virtually impossible to fully model at the beginning of the project. DCI’s T&M pricing model is inherently adaptive to such changes and allows the flexibility to jointly address new issues as they come up during the project. On the other hand, in a Fixed Price model, the service provider has a built-in incentive to avoid detours in order to stay within the original budget and such behavior could stifle the development effort. Moreover, the risk of what’s behind the wall is often mitigated by the addition of contingency to the FP quote and the addition of change-orders during the project.
The T&M pricing model also promotes a collaborative approach between DCI and the client. DCI maintains constant communication with the client, providing regular status updates on the tasks completed and planned, risks and issues, and money spent and left in the budget. Each time a client team member brings up a what-if scenario that could require significant additional effort, DCI will estimate the corresponding impact to the project schedule and budget, so the client can make an informed decision on the incremental cost vs. risk/reward of the additional effort. By contrast, the FP model could promote an adversarial us vs. them behavior with each side interpreting the signed contract to their maximum advantage. The client tries to hold the service provider’s feet to the fire and maximize the project deliverables while the service provider tries to complete the project as much within the budget as possible to maximize profit while delivering to the letter of the contract. Such contract-driven behavior is not conducive to a collaborative partnership.
DCI’s phased development process can alleviate any lingering concerns the client may have for the T&M pricing model. DCI’s estimation process results in a detailed cost estimate for Phase 0: Concept and Feasibility and Phase 1: Design and Prototype. The Phase 1 estimate is for budgetary purpose for the client’s internal approval process. To initiate the project, the client only has to commit to the relatively small Phase 0 which significantly mitigates the client’s risk. During Phase 0, DCI will typically create a requirements document, develop alternative concepts for the major sub-systems and drive the down-selection of these concepts, and create a preliminary Bill of Materials. The goal by the end of Phase 0 is for DCI and the client to have a more definitive direction and scope of the design. At the end of Phase 0, DCI will submit a revised project plan for the subsequent Phase 1 for design and prototype build. The client can now make a more informed decision on proceeding with the larger Phase 1.
- Fixed Price model is suited for a well-defined project scope where the service provider can accurately estimate the schedule and cost up-front, e.g. build-to print manufacturing.
- DCI’s Time and Materials pricing model is well suited for development projects with inherent uncertainty. Risk to the client of what’s behind the wall is mitigated by:
- Reduced up-front commitment only to Phase 0
- Regular communication, status updates and open book financials to avoid surprises
- Commit to Phase 1 after DCI submits a more definitive plan at the end of Phase 0
- DCI’s Time and Materials pricing model is inherently adaptive with combined judgment on project changes which strengthens the development effort. It is more conducive to a collaborative partnership based on achieving common goals.