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« Practical Project Management - Tips and Techniques - Part 1 | Main | Enterprise Search - A step Forward »

February 15, 2006


Graham Boundy

The main point I was trying to make in this article is that the buyer of a fixed price project has no incentive to finish and therefore they will dither.


I don't agree on some points where fixed price provide no incentive for the buyer and leads to poor client/vendor relationship. You made two contradictions. You stated that "In a fixed price contract a vendor and buyer agree on a price the buyer will pay for a set of products that the vendor will produce and deliver." Another paragraph states "The buyer may want to finish a project to realize a return on investment, but this is a soft incentive. If the system is not mission critical, and most systems aren't, the buyer has no incentive to finish". Why would customer spent something in which he is not sure that it is mission critical or benefitting the company? Nobody is wasting resources especially value for money. Preset condition to get involve in FIXED PRICE should be defined scope, requirements, and schedules. We mentioned schedules, FIXED PRICE should be acquainted with FIXED PERIOD to gain and realize return of investment. Even if there is indeed a spillover of efforts, that's the time you may charge a T&M manner.

Fixed priced contracts help your client budget and understand value for monies spent. You are taking a risk in bidding fixed prices. Your reward is the potential of doing the job for less cost than Time and Materials would have been thus increasing your profit. The fixed price protects the downside risk for the client. Don't let them manage your rates and your price to



Some intersting points. I will review them in context to a new post I am doing on pricing models. In the meantime, I will see what Graham's thoughts on this as this was originally his.


I agree, the buyer looks for a fixed price contract in an attempt to manage his budget, costs and risk. But he will also have a contingency fund in place to allow for scope changes, overruns and slippage. In affect he knows that the “Fixed Price” isn’t really a “Fixed Price” but a rough estimate of the cost of the finished product.

The buyer may want to finish a project to realize a return on investment, but this is a soft incentive. If the system is not mission critical, and most systems aren't, the buyer has no incentive to finish.
Let’s be clear on what I mean by “Mission Critical”: If it doesn’t work someone will die, or the company will go out of business. On projects that run over, and lots of them do, companies tend to continue to run the old systems and limp along until the new system is ready. Thus avoiding deaths or bankruptcy.

As long as the business has an alternative approach to getting their information or running their business they will wait a long time for a new system to be ready. And they will incur the additional cost. I know of a number of companies who didn’t intend to spend two or three times the original fixed price, but that’s what they spent because the business was willing to wait patiently for all the deliverables to be finished and they paid for changes because the projects had acquired momentum. Expectations had been set that the new system would be better if only people would be patient and wait for it. Once a project is in this mode, and the Business knows it is not costing them any more because the project is fixed price. Or they are willing to wait and pay for changes because the changes are reasonable justified and needed.

This is when the fixed price project model collapses and the death spiral begins… The vendor is interested in finishing, but may not have enough contingency to finish, so he is constantly looking for ways to remove things from scope, or add things to scope and introduce change requests to continue money flowing into his company, and thus keep the project limping along. The purchaser is in the opposite frame of mind: digging their heels in and maintaining or containing scope and limiting spending. As a result the vendor/client relationship suffers.

At the beginning of a project nobody intends to spend money on something they are not sure is mission critical or doesn’t benefits the company. At the beginning of a project, nobody thinks they are wasting resources. But after a project is started and has momentum it is very easy to fall into the trap of “just continue until we’re finished” and forget to look at the collapsing business case that got you there in the first place, or the change in business direction that makes the whole project un-mission critical. Once the project is rolling and money has been spent, when things run over time and budget, the company is more likely to invest “just a little more money” to get to the finish. In for a penny, in for a pound. They are less likely to abandon the project and be perceived as wasting the companies money. After all everyone wants to be successful, do the right thing and deliver the goods.

Unless the product being purchase is a commodity (which customer developed systems are not) then no matter how diligent a purchaser is they will never account for all of the preset condition required to FIX the exact PRICE based on explicitly defined scope, requirements, and schedules. Therefore there will always be a risk that the project will run over, that details will be missed that Time and Materials change request will occur.

My advice to clients is to break a project down into smaller and smaller functioning deliverable components until the pieces can all be managed easily on a time and materials basis. That’s the best way to eliminate risk from the project. The T&M project still has a schedule to be met and scope to be contained but now everything is manageable and everyone has an incentive to finish their work.

Fixed priced contracts only help clients budget the pieces they know about and gives them only an estimate of the value they will receive for monies they will spend. In reality they will spend over and above the fixed price on changes and won’t recognize any value until the project is completely delivered.

The biggest risk I take on when bidding fixed prices is that I will have to continually manage customer expectations about what is in scope and what is out of scope for the fixed price. My reward might be doing the job for less cost than the fixed price I quote thus increasing my profit. But not likely, because in a competitive situation I will have to bid low to get the business, and hope I can make up the difference in change requests to be profitable. The fixed price contract is a way for a purchasing manager to prove to his company that he chose the lowest price bidder. If there is more that one bidder there is no protection of the downside risk for the client, because everyone will “do what it takes to win the business” (i.e. low ball it) and hope to make up the difference (i.e. profit margin) on change requests.

In the Time and Materials scenario the market manages my rates – economics 101 - supply & demand. If I deliver quality product to my customer in a timely manner then that customer will perceive/receive value, limit their risk and continue to pay the market rate for my time.

If I fail to meet my customer’s expectations he is free to go to the market and find better skills at a price the market will bear.

Or if he feels my rates are too high he can go the the market looking for someone who will deliver the same value at a lower rate.

All I’m saying is let’s not be delusional about what a fixed price contract really is. It’s an estimate of how much the vendor thinks it’s going to cost to do the work prior to change requests. Everything after that is T&M.


One of the problems with fixed priced projects is that it assumes the customer knows exactly what they want before the project starts. The vendor may wish to tell the customer the holes in his spec or suggest other approaches but in the competitive situation that is not smart. So what one does is realize that there will be change requests.
On the flip side, if the spec is so tight there is no need for changes, it likely is not something requiring much creativity. Even in those cases, the business requirements may change base on new ideas the user has or some management change.
Even a simple rewrite of an old system has changes to make it better, faster, more user friendly, etc. The characteristic of our busines is that it is never static. New ideas, new software, new technology, business changes, and personnel changes, all affect the solution.
Breaking the project into manageable, shorter projects will make the project cost more menageable and by delivering value in the short term the overall project could pay for inself. This type of design is more challenging but make the project more manageable.
By the way, I think the expression is "in for a penny, out for a pound."

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