Why are fixed-price projects so risky?
Fixed-price projects have a rigid price for the entire project scope, regardless of what happens to it in the meantime. As a result, such operations are put in jeopardy whenever:
- a scope creep changes the amount of work to be done, increasing its costs,
- an estimate proves to be inaccurate,
- any unexpected circumstances arise, causing delays and additional costs,
- any market fluctuations affect the prices in the industry.
And, let’s face it: all of these issues are very common in the IT industry, making the fixed-price projects a particularly risky business.
But can that be changed?
What are the benefits of being able to price a fixed-price project?
It’s simple: customer like them much more than the time and material ones!
From the customer’s point of view, a fixed-price project is a guarantee of a single price for the entire scope of work. As a result, such an offer is a competitive advantage for your company - of course, as long as its price was calculated correctly.
How to price fixed-price projects? A perfect process
Selling fixed-price projects without losing money is not easy - but it is entirely doable with the right approach. Here’s what it looks like step by step.
Step 1: Create a simple and reasonable pricing
We have been working with hundreds of IT companies over the years. Our conclusion from this cooperation is simple: the simpler the pricing, the greater the profit margin.
Things such as:
- pricing combining the elements of fixed-price and time and material billing for a single project,
- changing the price of every working hour depending on the amount of work,
- unintive variables and additional discounts or increases in prices,
contribute to the chaos in the calculations, making the budget prone to mistakes. To add to that, preparing an offer in a few minutes is also impossible with so many overlapping pricing algorithms in place. As a result, budget estimates may simply be wrong at the time when a project is signed, dooming it from the beginning.
Step 2: Estimate the exact time needed to complete the project
To calculate the cost of work, you need an information on the amount of time you need to complete it - and it has to be as accurate as possible.
To come up with a time estimate, you need to consult all the managers and senior employees experienced in working with similar operations in the past. Their experience is the key to the success of the project.
Alternatively, you can use the historical data from your previous project to estimate the amount of work needed for a similar project. Therefore, we highly recommend accepting a fixed-price contract only for the operations your business is already familiar with - otherwise your project is at much greater risk!
After coming up with an estimate, you can use a dedicated tool - such as Primetric - to keep track of all your findings. If you can, you can also add some general financial estimates to the equation. At this stage, you can use them to tell whether it is worth for your business to proceed with this offer any further.
Step 3: Determine what people you need to complete the project, and how long they need to work on it
If you thought that estimates are all you need to price a fixed-price projects, you were mistaken - and that mistake could have costed you thousands of dollars.
Before you even start thinking about the final price, you need to determine what specialist you need to complete the project, as well as the time they would most likely need to complete their part of the job. At this stage, simply focus on the skills or specializations and their required availability - such a draft workload management will be a base for further analysis.
Step 4: Use draft allocation to assign people to the project and see their costs
This step is probably the most complicated of all in the pricing process. However, it can be broken down into two parts that make the entire operation much easier.
Check people’s availability for a given period
First, to choose the right people for the project, you need to check whether they are really available at the time a new operation is about to begin.
To do that, you can use a more general approach. Create a list of people with some free time in Excel spreadsheet, or use the unutilized time cost in Primetric to see every employee with some free time on their hands.
Alternatively, if you already have a particular skill in mind, you can use the project search bar to look for the right people. The information on their utilization will be displayed on the right.
Allocate people and create a draft project
After making sure that you have the right people for the job, you can allocate them to the project based on the estimates you made earlier in the process. Later on, these allocations can be used to calculate the cost of work for each and every employee, consequently providing the managers with the information on the costs of the entire project.
Step 5: Add a margin and send an offer!
After calculating the costs of the project, you can add a desirable margin to them. Either use the first-degree margin here, or make sure that your fourth-degree margin contains all the additional costs you need to consider before deeming the project profitable.
Is there a way to avoid mistakes in fixed-price projects?
Yes, of course!
Based on our experiences with dozens of managers from IT industry, we have even prepared a list of the most common issues you might encounter in the finances of a fixed-price project. You can read all about them in our article about selling fixed price projects without losing money.
I want to learn more about project finances!
Great - you’ve come to the right place!
Visit Primetric blog and read about:
- overhead absorption rate and its impact on the project budget,
- managing project costs both before and after it starts,
- revenue projection that will help you adjust your budget better than ever,
- in-depth project financial analysis,
- cost overrun in projects, and what it means for your finances.