One of the key decisions a customer will make during the start of a project or product is the type of contract to negotiate with the consulting partner, assuming there is a need for a partner. Before we get to popular contract arrangements, let us differentiate fixed vs. variable costs and scope. These are factors that you should consider to finalize the contract type:
- Fixed and Variable Cost – Cost can be fixed or variable. To use a simplistic example, a fixed price menu is fixed cost and an a la carte menu is a variable cost.
- Fixed and Variable Scope – Scope can also be fixed or variable. In fixed scope, scope is clearly defined with clear boundaries and requirements and in variable scope, there is room for scope change through the course of the project.
With this understanding, let us look at the three most popular contract or Statement of Works (SOWs):
- Time & Material (T&M)
- Fixed Bid
- T&M with Cap (also called Not To Exceed)
There are other types of contracts (for e.g. outcome/results based – risk/reward, value or profit based), but a majority of service contracts fall in the above three categories. Let us go into the three common pricing models in detail.
Time & Material
Time & Material is an input based pricing model. Time & Material is in many cases the preferred vehicle of consulting partners. Simply put, it is the number of hours charged at a given billing rate for the various people working on the project. For e.g. if a partner is called to do a simple CRM “out of the box” implementation estimated at 500 hours and the billing rate is $200 per hour.
- T&M Professional Fees = Number of hours x Billing rate
- Professional fees for the specialist = 500 hours x $200 per hour = $100,000
There maybe other expenses involved (for e.g. travel), but the above example covers the key labor considerations.
Fixed Bid
Fixed fee is an output or results based pricing model where a fixed fee for the entire project is agreed upon irrespective of the actual hours spent by the consulting partner. Fixed bid projects have increased over the past decade as customers (i) look to adhere to the agreed upon the budget or strategy plan and (ii) want the consulting partner to take the project delivery risk and have skin in the game.
Let us say the same customer signs up a consulting partner to do the above said CRM implementation for $120,000. The partner has done tens of such engagements, is very good at it and knows the ins and outs of it:
- Fixed Fee = $120,000 for professional fees
Usually, the fee is broken into milestones or stages. For e.g.
- Milestone 1 – Requirements and Design completed – $30,000
- Milestone 2 – Configuration and development completed – $40,000
- Milestone 3 – Testing and deployment completed – $50,000
T&M with Cap
Time & Materials (T&M) with Cap can be thought of as a hybrid between T&M and fixed fee. The customer pays the consulting partner on a billing rate basis, BUT (and it is a big but) with a Cap i.e. the partner cannot charge more than the cap. In the T&M example, we said:
- Fees for the consulting partner = 500 hours x $200 per hour = $100,000
If the customer signs up a consulting partner to do the CRM implementation with a T&M Cap of $100K, the partner CANNOT exceed the $100K limit i.e. $100K becomes the Cap.
In summary, we introduced three common pricing models with simple examples. There is a lot more to contracts than these simple examples, but I hope these differentiate the three major available contract vehicles.
